Save Dollars on Your Brokers Commissions
February 1, 2001 Tom Pope
As chief financial officers struggle with a nonprofit’s finances they would probably like getting back some of the money they spend just to coordinate the funds.
That’s just what the Goodspeed Opera House Foundation in East Haddam, Conn., has been doing. A portfolio of $7 million in trading brings back around $15,000 a year consistently for the nonprofit.
The income returns to the nonprofit from what ordinarily would have been part of the commission going to the broker for the trading. It’s called commission recapture or a commission recapture program (CRP).
Goodspeed’s endowment provides for the general operating needs of the nonprofit’s two stages where six musicals are presented annually. The endowment is structured with equities and a fixed income where the nonprofit maintains a value manager, a growth manager and bond manager.
However, not each applies to a CRP approach, according to Dawn Starr, the opera’s chief financial officer. "Our value manager actively buys and sells equities – the perfect way to recapture those funds," she said. "Nonprofits not currently participating in CRP should investigate the process."
CRP is a process where a fund receives a rebate from a portion of the commissions known as soft dollars. Soft dollars are portions of a broker’s commission that investment managers use to pay for research whether it comes in a proprietary way or arrives by third-party researchers.
The CRP directs an unbundling of the commissions to separate the research charge or the soft component from the execution charge. That charge then returns to the investor who paid for it. The CRP approach assumes that the recapture broker is competitive in any execution and its price.
The beginning CRPs came with the U.S. Department of Labor’s May, 1986 Technical Bulletin, which declared that commissions should be considered an asset of a plan and that sponsors had an obligation to monitor and control the commissions.
The number of nonprofits using CRP is hard to determine, according to Howard J. Schwartz, chief executive officer and president of Lynch, Jones & Ryan, (LJR) an institutional trading firm. LJR is a wholly-owned subsidiary of Instinet Corp., a Reuters Company with offices around the world and is based in New York City. Presently the firm helps around 200 nonprofits.
"Probably nonprofits would be the ones to flock to this financial concept without hesitation," he said. "The fiduciary responsibility of the trustees means they have stronger needs to watch operating expenses. CRP would be a no-brainer," said Schwartz.
LJR originated recapture programs in 1986 to help pension plans reduce transaction costs. The typical CRP client has pension assets between $500 million to $1 billion with the smallest fund maintaining around $50 million in assets.
Schwartz explained that the global market for commission recapture consists of around 10,000 possible institutions that contain $500 million or more assets, yet only 6 percent of the total market currently uses the concept.
Typically, CRP can reduce transaction costs from about 6 cents to 3 cents a share, according to Schwartz.
Most funds don’t have the clout with money managers to lower a commission rate because money managers trade on a block basis with multiple accounts at the same time. The nature of the business means that they don’t want different commission rates with various clients.
But, the CRP is a relationship between the fund and a broker where the broker agrees to execute the business in equities or fixed income with a rebate in mind.
"The money manager is uninvolved. He doesn’t care if the broker gives back half the commission to the plan," said Schwartz.
Generally, the choice of a broker comes from the investment manager, but major brokers carry relationships with many money managers. A client simply needs to send a letter of direction that asks the manager to execute a percentage of the overall trade with a specific broker. In return the broker agrees to rebate 50 percent of the commission back to that account.
The letter typically asks the manager to carry on 25 percent to 35 percent of the transactions in this way. This should pose no great difficulty to the manager, according to Schwartz, as the money manager is probably already doing business with a broker.
"It’s a 34 cents stamp and a one page letter," he said. "The implementation of the process is that simple," said Schwartz.
After the letter, a few hours per calendar quarter to monitor the progress remains as the only management effort for the nonprofit’s CFO. Most firms that handle such transactions also provide client support groups that send out monthly reports. Clients usually have 24-hour access to view accounts through software.
"It’s a no brainer," said John P. Casey, treasurer for the Altman Foundation in New York City. The foundation’s roots go back to the retail B. Altman and Company and its mission strives to aid schools, healthcare and the arts in New York City. The Altman Foundation started using CRP this year for its $275 million assets, although it isn’t using CRP for the emerging market. It chooses to use CRP basically for its equity portfolio.
"If the trade can be made for 4 cents a share with XYZ company and another company is 6 cents, then I’ll go with the other company," he said. "The process must be the lowest cost for the trade and by trading through a CRP broker, I can gain some of the commission back."
To date the Altman Foundation has retrieved around $10,000. "It’s free money I can apply to operating costs," Casey said.
The biggest fear money managers have is that a fund may be asking the manager to lose too much of their soft dollars for information. If Casey told a manager to trade 70 percent through a CRP system, the manager might lose its ability for new issues on the market and would lose research information.
"All I’m doing is saying they should put up to 25 percent of the total trading," Casey said. "Then I’m not upsetting anyone. So, I’ve limited it."
Most brokers provide investment research to attract business, according to Schwartz. "If you don’t provide the research you can use that 3 cents to offer a rebate," he said. "They can produce some research for 50 clients yet don’t have to produce it 50 times. The crucial point is there is money available for both CRP and also research."
So if CRP is so great why is only 6 percent of the market using the method? "CRP is not something readily apparent," Schwartz said. "It’s still a relatively new concept and has to be explained to the trustees and directors. It’s inside baseball."
Most funds use more than one recapture broker, yet according to Schwartz the corporate world generally uses one. The public world worries about Sunshine laws with a perception of favoritism so may use three brokers.
"If there were other parts of our portfolio that could apply to CRP, I would expand it," said Starr.
The opera also used CRP when it changed investment managers. The nonprofit went through LJR to liquidate the account and the differential was 2 cents on a share that ended up saving $1,400. Goodspeed gave its manager limits of 75 percent so if the manager came across a particular stock needing research, the arrangement would not hinder the manager.
"Even though we only directed the manager to going 75 percent with CRP, the manager pretty much directs it 100 percent , so it’s not a burden for them," Starr said.
Tom Pope is a New York City-based journalist who writes about management issues.