Fidelity's New Research Payment Approach

Friday's Wall Street Journal's Money section featured an article about how some fund managements are changing the manner in which they compensate brokers for so-called "research." In the wake of the notorious Spitzer settlement years ago, after the dot-com bust, research is now supposed to be independent beyond question.

Thus, soft dollar arrangements are becoming more heavily scrutinized. This practice involves the fund agreeing to trade with a broker in payment for 'research.' The effect may be to charge clients more for the trades, while the management gets 'free' research. Nice trick, eh?

Fidelity Investments is mentioned at the end of the piece as departing significantly from all other firms in fixing this situation. They have begun to sign deals

"in which Fidelity Management & Research- which oversees the funds- pays for research instead of fund investors. Fidelity negotiated flat rates for the research and for the commission rates on the trading- a move known as "unbundling." "

I love this. Of course, no other major fund management firms are joining this practice. It would reduce their profits by shifting the costs of 'research' to them from the customers' trading expenses.

To me, the Fidelity move makes perfect sense. Despite Spitzer's "best" efforts, research can never really be 'independent.' There is always the potential for an asset manager to somehow compensate an 'independent researcher' to provide beneficial reports on companies whose equity or debt the manager holds in funds. Moving the source of conflict of interest a little further down the food chain will never remove it entirely.

However, research properly belongs as an expense of the fund management in providing asset management services to clients. To the extent that it really has any material benefit in the first place. If it had, don't you think investment banks would have charged their other functions, and customers, for the product of the research departments?


As one of my investment banking colleagues puts it, 'why not just call it "marketing," since that's what "research" really is.' That is, it becomes a crutch which managers use to justify their selections, if they are not sufficiently confident to simply accept responsibility for them in the first place.

Still, Fidelity's move at least puts the customer first, and makes Fidelity sure it wants the research it uses, because it's paying cash for the service.