“A United Kingdom securities regulator could change the way Wall Street firms operate more dramatically than Eliot Spitzer has,” writes Silvia Ascarelli in today’s Wall Street Journal.

“Mr. Spitzer, the attorney general for the state of New York, has forced major Wall Street securities firms to sever some ties between investment bankers and stock-market analysts and to finance some independent research. The terms are part of the $1.4 billion so-called global settlement reached earlier this year following allegations that some analysts wrote overly optimistic research reports on individual companies in hopes of currying favor with investment-banking clients.”

“The U.K. Financial Services Authority, in an effort to tackle various conflicts of interest, wants money managers to pay cash for research and other products, rather than to pay for it through their commission checks. Otherwise, it says, fund managers can continue to pass on some of their costs to their customers, be they mutual funds or pension funds. Doing so gives them an incentive to direct business to brokers to pay for these extra services, rather than to pick the broker offering the best deal on a particular trade.”

“The proposals, which are being closely watched by regulators in the U.S. and elsewhere, could mean more job cuts in research departments and greater pressure on second-tier brokers as more trading is concentrated in the hands of even fewer firms. It also would force brokers and fund managers to put a price tag on research, which is now considered “free,” and possibly reduce the estimated $2.6 billion that U.K. investors spent on commissions last year. If adopted, the rules would affect every fund-management firm in the U.K., many of which are foreign-owned, and their brokers, a list dominated by the major Wall Street firms.”

” ‘No way would there be 20 analysts covering Nokia,’ the telecommunication-equipment maker that is one of the biggest European companies, said Mark Brown, global head of research at ABN Amro in London. ‘There would be three to four top teams and three to four aspiring teams.’ “

“Even a watered-down version that just requires a breakdown of what the commission bill covers could add to the pressure on the equity-trading side of brokerage firms and fund managers, both of whom have seen their profitability collapse because of the bear market. Fund managers are unlikely to want to pay for all the research reports they now get. Indeed, some argue that even just requiring greater transparency will inevitably lead to fund managers balking at paying for some research through their commissions.”

“The deadline for commenting on the FSA’s proposals is Friday, although a final verdict, followed by draft rules, isn’t expected until next year. An FSA spokesman declined to comment on the likely result, but its new chief executive, in a speech 13 days ago, said the agency would look for ‘workable solutions’ for its belief that soft commissions, or ‘softing,’ and ‘bundling’ distort the market and create conflicts of interest.”

“Under softing, brokers pay for certain third-party services, most frequently dealing screens but can also include independent research, computers and custody services, that are used by fund managers. About 6% of U.K. commissions are ‘soft,’ Greenwich Associates estimates, or one-third the percentage in the U.S. The FSA estimated it at 10% in 2001. ‘Bundling’ is combining in-house brokerage research and trading costs into one commission rate. In its proposals, the FSA noted that estimates range as high as 40% of commission costs go for other services, either through bundling or softing.”

“A survey to be released this week by consultancy Greenwich Associates found that 58% of those fund-management firms surveyed expected the FSA to ban the use of so-called soft commissions. A smaller 39% predicted ‘softing’ would be banned completely, while just 3% thought there would be no change.”

“Fund managers widely expect the FSA to continue to allow bundling. Some 91% told Greenwich Associates that they expect it to be permitted but with increased transparency. Only 3% expect the FSA to ban the practice, and 6% said they think nothing will change.”

“The FSA’s critics, of which there are many, claim the proposals could make share trading more expensive by widening the gap between buy and sell orders, which could more than offset savings in commissions. It also could make it harder for independent research outfits, which now often get paid indirectly. Moreover, it could prompt some fund-management firms to leave the U.K. in order to avoid the rules.”