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Sunday, March 23, 2008
Proposed Changes to Form ADV -- Missing The Point?
New York, NY - In recent weeks the markets have discussed the strengths and weaknesses of the SEC's recent proposal to modify Part 2 of Form ADV, which would require that registered investment advisors explain their business practices in "plain english" versus taking the "check the box" approach that is currently required.
It is clear to the team at Integrity Research Associates that the current Form ADV needed to be overhauled as most investment advisers had grossly under reported their use of soft dollars for years. After all, any money manager that pays more than a pure execution only rate, and also receives sell-side research is actually "paying up" and using soft dollars. However, data from Form ADV shows that only 60% of all money managers report that they use soft dollars.
We also admit that a "plain english" description is more useful than the current information disclosure format. However, we also think that the proposed changes to Form ADV really miss the point as they don't provide sufficient transparency into one of the most opaque aspects of the investment manager / client relationship -- how investment managers spend their client commissions, and the services they receive as a result of these practices.
One of the reasons we feel that the proposed changes are missing the point is because we believe that investors have the right to know what their investment managers are doing with their assets. Interestingly, it seems the SEC agrees that it is important that clients (investors) receive sufficient information about the adviser and their practices to make informed investment decisions. The following paragraph is from Section I of the SEC's recent Amendments to Form ADV.
"Unlike the laws of many other countries, the U.S. federal securities laws do not prescribe minimum experience or qualification requirements for persons providing investment advice. They do not establish maximum fees that advisers may charge. Nor do they preclude advisers from having substantial conflicts of interest that might adversely affect the objectivity of the advice they provide. Rather, investors have the responsibility, based on disclosure they receive, for selecting their own advisers, negotiating their own fee arrangements, and evaluating their advisers’ conflicts. Therefore, it is critical that clients and prospective clients receive sufficient information about the adviser and its personnel to permit them to make an informed decision about whether to engage an adviser, and having engaged the adviser, how to manage that relationship. "
Consequently, it is strange to us that in its Form ADV proposal the SEC has clearly ignored one of the most obvious ways it could reduce potential conflicts of interest and promote greater transparency -- by mandating that investment advisers disclose specifically what client commissions are being spent on.
In the past, when such a proposal was discussed, the brokerage industry argued they could not "unbundle" research from execution due to the lack of good information systems.
However, the FSA and the UK money management industry addressed this issue a few years ago by mandating that money managers provide clients with a good faith estimate of how much of client commissions was spent on execution services and investment research.
Unfortunately, the U.S. brokerage and money management industries have both convinced the SEC that this information was either too difficult to produce, or it would cause too much confusion. They argue that investors really can't understand the intricacies of soft dollars.
The truth is that neither the brokerage nor the money management industry would benefit from clients knowing this information as it would force the buy-side to actually pay for the various research and advisory services they receive, and it would force the sell-side to justify the amount of commissions they charge clients. An opaque commission environment would enable the current inefficient market to continue.
Ultimately, the interests of retail investors, who would benefit from knowing how their commission assets are being spent, have been overlooked once again. In addition, investors have not been provided enough of the right kind of information to enable them to make a good decision on who does the best job balancing investment returns with the costs associated with generating those returns.
We hope that eventually the SEC will understand that protecting individual investors, and providing them with the information they deserve is much more important than promoting the status quo.
Posted at 03:18 pm by mwmayhew
 | | | Bill George
March 30, 2008 09:22 AM PDT
The Road Not Taken
How did we get here?
The other other day I had an epiphany. I thought to myself . . . "self, you really need to perform a 'reality check' just to make sure you haven't imagined some of what you think has happened over the last several months". Then I thought, a good place to start my 'reality check' would be by reviewing the audio transcript of the July 12, 2006 Securities and Exchange Commission "Sunshine Meeting". This is the public meeting at which Chairman of the SEC Christopher Cox, the SEC Commissioners, and members of the SEC staff discussed then unanimously approved the interpretive release known as, Commission Guidance Regarding Client Commission Practices Under Section 28(e) of The Securities Exchange Act of 1934.
As I listened to the audio transcript again on my computer's media player I was stunned by the how much interesting detail I had forgotten. I was also impressed by the number of times SEC Chairman Christopher Cox, the Commissioners, and the staff mentioned and agreed on the importance and the priority assigned to the pending (promised?) interpretive guidance on transparency and disclosure.
The audio transcript of this "Sunshine Meeting" is 48 minutes and 2 seconds long and is well worth reviewing in its entirety, but if you don't have the time to do so I believe you can get a good idea of the impressions and hopes created by the meeting participants' statements by listening to Chairman Cox's introduction to the meeting in its entirety, then using the slider on your computers' media player to navigate to what I believe are the most relevant sections of the meeting.
Here is the URL of the July 12, 2006 SEC "Sunshine Meeting" > http://www.connectlive.com/events/secopenmeetings/secopenmeetings-071206-archive.asx
Slider Position Brief description of content at this slider position
3:35 Christopher Cox mentions the importance of full brokerage commission disclosure.
8:06 Christopher Cox mentions Commission Sharing Arrangements*
11:36 Robert Colby discusses the conditions that advisors and brokers must meet to have the safe harbor available to them.
12:05 Chairman Cox asks Robert Colby to describe how Commissions Sharing Arrangements* will work under The Guidance. This explanation includes a discussion about third party research.
16:30 Commissioner Glassman on unbundling and transparency
23:10 Commissioner Atkins discusses the importance of the next phase of guidance on disclosure and transparency and bundled commissions.
29:36 Commissioner Atkins asks Andrew Donohue, Director of the SEC Division of Investment Management a question, in his answer Director Donohue includes a comment about the importance of the next phase of guidance on transparency and disclosure.
33:29 Commissioner Campos mentions the importance of soft dollars and refers to the magnitude of the use of soft dollars. As evidence of the importance of soft dollars Commissioner Campos mentions a Greenwich Associates’ study which reports soft dollar use at almost one billion dollars in 2005. Mr. Campos seems unaware that Greenwich Associates' estimates of soft dollars have always significantly underestimated institutional soft dollar use because the Greenwich studies report only the soft dollars generated in third-party fully disclosed brokerage, but the Greenwich studies do not report soft dollars generated in bundled undisclosed full-service brokerage arrangements. Under Section 28(e) all commission amounts "paid-up" above the fully-negotiated execution related costs are soft dollars, irrespective of whether those paid-up commissions are used to purchase third-party research, or proprietary research [as allowed in Section 28(e)] or whether they are used to acquire goods and services that qualify under interpretations of fiduciary discretion (see the accompanying document titled, Drilling Down)
44:30 Commissioner Annette Nazareth expresses her thoughts on the importance and priority of the next phase of SEC Guidance on disclosure and transparency in all institutional client commission arrangements.
47:00 Vote taken - unanimous approval of The Guidance
* At some point after this meeting the SEC changed the definition of Commission Sharing Arrangements and defined a new class of Commission Sharing Arrangement which the SEC gave the name Client Commission Arrangements. This new name seemed necessary so that the activity described in Client Commission Arrangements would not violate any of the many regulations designed to prevent abuses which can arise from the splitting and sharing institutional clients' commissions.
Best regards,
Bill George
Title credit - see > The Road Not Taken by Robert Frost http://www.bartelby.org/119/1.html
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| | | Bill George
March 25, 2008 10:44 AM PDT
I hope that Mr. Mayhew has either sent this article, or a Comment Letter expressing his thoughts, to the SEC. I believe it’s important for the SEC and the public to see Mr. Mayhew’s observations about the proposed amendments to Form ADV. And, I hope that in his communication to the SEC he has, or will stress the importance of the real disclosure of the uses of advisors' clients' brokerage commissions.
I hope that Mr. Mayhew, and others who might comment to the SEC, will stress the observation that without true disclosure, history has repeatedly demonstrated that there is great temptation for fiduciaries and brokerage firms to use bundled undisclosed brokerage arrangements to conceal the exchange of clients' brokerage commissions for products and services which may not qualify under Section 28(e) and which may not qualify as acceptable under fiduciary discretion.*
The true disclosure of fiduciaries’ clients' brokerage commission uses would provide mutual fund directors, plan trustees and plan sponsors with valuable insight as to the actual uses of plan assets. And true brokerage commission disclosure would also allow interested parties to perform more accurate cost benefit analysis on the services and goods purchased with fund assets.
*For more on this history see the Global Analyst Research Settlement at > http://en.wikipedia.org/wiki/Global_settlement and http://www.sec.gov/news/speech/factsheet.htm
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