Fidelity Expands Deals to Separate Trading and Research Fees

NEW YORK (AP) -- A year into its experiment to pay Lehman Brothers Holdings Inc. separately for executing stock trades and research, Fidelity Investments has struck similar arrangements with several other brokers and is beefing up its in-house team of stock analysts to reduce its reliance on Wall Street.

Brokerage firms have traditionally charged their biggest trading customers so-called bundled commissions that are padded to include costs of research, sales support and other services. Fidelity sent shivers down Wall Street when it began dictating a new payment model for equities trading last year, but some brokerage firms now say they are adjusting.

"It's more than an experiment," said Rob Karofsky, head of global equity markets for North America at Deutsche Bank Securities, which inked an unbundling deal with Fidelity last November and has similar arrangements with a handful of other clients. "In this environment, with decreasing commission rates and the proliferation of electronic trading, it's incumbent on all broker/dealers and their clients to partner up and achieve goals that are mutually beneficial."

Fidelity won't comment directly on how many brokers now receive a flat annual fee for research while the fund giant's traders negotiate commission fees on specific transactions. Deutsche Bank AG and Lehman have publicly disclosed such arrangements, and firms as diverse as Morgan Stanley and middle-market investment bank Thomas Weisel Partners Group are known to have inked similar deals.

Unbundling, which is aimed at lowering costs for mutual fund shareholders, pinches both Fidelity and its Wall Street brokers. Fidelity Management & Research, the fund company's advisery arm, pays cash out of its own pocket for research that used to come out of commissions deducted from fund assets. The move allows fund traders to negotiate lower unbundled trading costs at a time when regulators are pushing for more disclosure on fund expenses and limiting how shareholder money can be spent.

"It's the economic equivalent of reducing our management fee," said FMR General Counsel Eric Roiter.

Brokers, meanwhile, lose some revenue. Fidelity paid Lehman less than $7 million for research in the first year of the program, according to people familiar with the program, a number lower than previously reported in press and analyst accounts.

Traders at Fidelity's funds have negotiated commissions that average 2 cents to 2.5 cents a share, according to published reports and analysts, a blended rate that includes electronic trades at less than a penny share because they require little brokerage oversight. Its rivals typically pay 3 cents to 4 cents per share on a bundled basis, according to analysts.

"A 2-cent deal is good for Lehman as long it can negotiate a mix of trades that limits the toxic waste," or trades in less liquid stocks that require time and capital to execute, said Brad Hintz, an analyst at Sanford Bernstein.

Unbundling, however, adds to Wall Street's continuing problems in funding research departments. Commissions have become the primary source of research revenue after regulators banned brokers from using investment banking fees as part of settlements in 2003 and 2004 over biased research.

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