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March 17, 2004
MMA Praxis Eliminates Soft Dollar Arrangements
    by William Baue

MMA Praxis joins Domini in disavowing soft dollar use; other socially responsible investment firms continue the practice within legal limits while some consider cessation.

Today, MMA Praxis Mutual Funds announced its voluntary elimination of the use of "soft dollars," a legal but controversial and complex arrangement whereby investment firms buy research and information tools without cash. Many investment firms pay brokerage commissions that bundle these "soft dollar" research fees with trading costs. These financial hits are not reflected in expense ratios, though they can drag on performance, in which case investors shoulder the cost, often without realizing it. A survey of other socially responsible investment (SRI) firms yields mixed results, with several firms using soft dollars within legal limits and others foregoing the practice.

While it is difficult to explain the process of using soft dollars, it is easier to identify the issues it raises--namely, who bears the cost for investment research and information tools and, at a deeper level, how this expense is disclosed to investors.

Soft dollar arrangements are perfectly legal, and the US Securities and Exchange Commission (SEC) clearly defines "safe harbor" guidelines that prescribe their use. The legitimacy of soft dollars, however, is a matter of debate. Soft dollar advocates liken them to frequent flier miles, with trades analogous to paid travel and research credit analogous to bonus free travel: it would be folly to forego this legal opportunity, they maintain. Soft dollar skeptics point out that brokerages often artificially inflate commissions to reflect the research premium: research and information tools are never free, and soft dollars obscure this cost, they argue.

Disclosure is the crux of the matter. If investment firms pay cash for research and information tools and choose to pass this expense on to investors, the expense ratio discloses this cost. (Investment firms can, of course, choose to absorb the expense themselves.) When investment firms use soft dollars, they pass the expense on to investors through brokerage commissions that are not transparently reported, but get buried in obscure filings and aggregated with multiple funds in the firm's family. This makes it extremely difficult, even for the most savvy investors, to ascertain exactly what price they are paying for this research.

"Soft dollars are legal and accepted, but it doesn't feel right any longer to ask shareholders to pay these costs as commission expenses," said John Liechty, president of MMA Praxis Mutual Funds and senior vice president of financial services for Mennonite Mutual Aid (MMA). MMA is an Anabaptist organization that practices faith-based financial stewardship. "We are primarily sending the message that we're ready to absorb these research expenses as a cost of doing business and no longer pass them along as commission expenses to investors."

Massachusetts Financial Services (MFS), beleaguered by market timing improprieties, recently announced its cessation of soft dollar use. The SEC is currently considering rule changes to further restrict "safe harbor" boundaries for soft dollar use, for example by excluding computer-related expenses or publication subscriptions. Investment firms that use soft dollars will therefore have to prepare for the possibility of such rule changes, and may find it necessary to explain to their investors how they use soft dollars.

Mr. Liechty clarified that MMA Praxis has always operated within the SEC's "safe harbor" parameters. Elsewhere in the SRI community, some firms forego soft dollar arrangements, as MMA Praxis now does, and some operate within safe harbor.

"Domini does not pay soft dollars," said Adam Kanzer, general counsel and director of shareholder advocacy for Domini Social Investments. Part I of Domini's Form ADV filing with the SEC has long reflected this commitment, and Domini is revising Part II of the form by the end of March to formally decline the option of using soft dollars in the future.

The Calvert Group, Trillium Asset Management, and Pax World Funds all use soft dollar arrangements within "safe harbor" limits. Calvert has additional checks in place to monitor the issue.

"Calvert has a Soft Dollar Committee that meets periodically as well as makes quarterly reports on the use of soft dollars to the Calvert Mutual Fund Boards," said Elizabeth Laurienzo, Calvert's director of corporate communications.

Pax World is admittedly wary of soft dollar arrangements.

"We studied the SEC language concerning soft dollar arrangements, and saw where it could easily be abused and therefore kept ourselves to limited, if any, involvement," said Anita Green, Pax World's director of social research.

Pax World currently has three soft dollar agreements: two for market monitoring terminals and one for performance attribution data.

"These agreements benefit our shareholders since these are necessary items which would have been bought if not received through soft dollars," Ms. Green told "Nonetheless, the Pax World boards of directors are presently reviewing the subject of soft dollars with our counsel and we expect to have a decision on whether or not to continue them by our annual meetings in June."

Reader Feedback
To the Editor,

Soft dollars are not all evil. Because the practice is beneficial when applied appropriately, it is important to understand soft dollar rules. In the post-Enron days, it's tempting to over-react--we'd like to make a case against precipitous judgment.

"The [Securities and Exchange] Commission has defined soft dollar practices as arrangements under which products or services other than execution of securities transactions are obtained by an adviser from or through a broker-dealer in exchange for the direction by the adviser of client brokerage transactions to the broker-dealer." In 1975, Congress provided that an advisor shall not be deemed to have acted unlawfully if he causes an account to pay more in commissions provided that the services rendered in exchange equal the value of those commissions. This Section 28(e) is the so-called "Safe Harbor". Managers would be in violation of the "Safe Harbor" if they used soft dollars for their own benefit--a practice that Trillium Asset Management has never considered.

In the case of Trillium Asset Management, annual brokerage fees, carefully monitored, total less than one tenth of one percent of the value of an average account where we have discretion over trading allocation. No soft dollars are used to purchase anything except beneficial research.

Too often individuals on Wall Street have exploited clients--hence we have a regulated system. Trillium Asset Management supports regulations and has conservative policies and procedures. We feel that the judicious use of soft dollars is fair and helpful in the pursuit of our clients' goals.

Joan Bavaria
Trillium Asset Management


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