New York—As the SEC considers new commission disclosure
guidelines, the question is how far will the SEC go? The benchmark is the commission disclosure
regime instituted in the UK by the Financial Services Authority in 2006, and
now being adopted in other domiciles. Given
the SEC’s tepid enthusiasm for commission disclosure, it is likely that US
guidelines will be less far-reaching than those implemented in the UK and now
spreading across Europe. This view is
reinforced by a recent email from the securities industry trade association
SIFMA indicating that both securities firms and investors are trying to
persuade the SEC that less is more as far as disclosure is concerned.
The email is the follow up to a meeting organized earlier
this month by SIFMA with SEC staff. The
meeting included investors who discussed how they used soft dollars. According to the email, the buy side
representatives stressed that they set the prices for research based on their
perceived value of the research, which “hopefully will lead [the SEC] to
conclude that a sell side cents per share type of unbundling would not be
useful information.” In other words,
instituting disclosure requirements similar to those in the UK and France would
not be appropriate in the US. Apparently not discussed was the impact
that client commission arrangements are in fact creating sell side cents per
share type of unbundling, at least for the smaller and mid-sized broker
research which is flowing through the arrangements.
One of the big concerns within the securities industry is
that unbundling of research will lead to sales tax. Up until now, the bundling of research with
execution has helped to shield proprietary research from sales tax. Independent research, which for the most part
tends to have explicit pricing, is subject to sales tax.
The email concludes that the SEC should provide guidance
that research is “a component of
integrated services provided through soft dollar arrangements, and that
additional burdens or costs should not be imposed on providing such services.” That is, the new rules should confirm the
current state of affairs and not bother with any intrusive new disclosure
guidelines. Given
that the IM division has many other competing priorities such as 12b-1 fees and
hedge fund regulation, why not give the staff more excuses to keep commission
disclosure buried in the inbox?
In a recent
speech, Andrew Donohue, Director of the SEC’s Investment Management division,
suggested that commission disclosure guidelines are likely to be focused on
fund directors rather than broader based disclosure (click here to see our discussion.) This, plus the lobbying
from SIFMA and the mutual fund trade association, indicates that any US commission
disclosure regulation will fall short of European standards.
The text of the SIFMA email follows:
Given IM Director Buddy Donohue's background
as a General Counsel to two major fund complexes, it is not surprising that the
SEC is focusing on enhancing the type of qualitative and perhaps
quantitative disclosure that is made to fund boards in conjunction with soft
dollar arrangements. These disclosure enhancements may also flow to other
types of advisory clients through amended Form ADV, Part 2 disclosure.
The SEC staff, while not specifically confirming the content of the revised ADV
Part 2, has made a point, in the context of soft dollar discussions, of
underscoring their intention to finalize their ADV rule in the near future.
Much of the meeting was devoted to buy side
representatives relating their views on how they approach, value and analyze
soft dollar arrangements. This discussion seems to validate the view
which many in our group have expressed over the years that providers of
soft dollar services tend to be price takers, rather than price setters, and
that the "value" of the research component is very much in the eyes
of the beholder. It seemed that the SEC staff understood this, and
hopefully will lead them to conclude that a sell side cents per share type of
unbundling would not provide useful information. In turn, such a
conclusion might be helpful in addressing potential state tax issues, at
least in the proprietary context.
The point was also made that that from a
policy standpoint, it would be helpful if the SEC, in the context of rulemaking
or interpretive guidance, would clarify that research is a component of
integrated services provided through soft dollar arrangements, and that
additional burdens or costs should not be imposed on providing such services.
Posted at 07:08 am by Sanford (Sandy) Bragg
 | | |
Bill George
October 30, 2007 08:25 PM PDT
I have a few observations about SIFMA's observations:
I found it interesting that SEC meeting and the observations in the email don't don't include any comment on any effort to coordinate SEC disclosure requirements with those of the Department of Labor Employee Benefits Security Administration's Form 5500 disclosure requirements. It seems to me that harmonizing these disclosure requirements might be beneficial.
I also found the observations in the second paragraph of the email troubling because they seem to run counter to the concept of fully-negotiated commissions and they open the door to the very subjective valuation of services, without the identification of those services. I believe good identification and disclosure is necessary in order to test for appropriate use of institutional clients' commissions under Section 28(e) and under fiduciary law.
Furthermore, I believe transaction cost analysis has revealed the cents-per-share costs of execution fairly well. And, in my experience, it's obvious that when a buy-side institution wants a service* provided by a full-service brokerage firm, there is a negotiation which includes an implicit understanding of the average costs of transactions and the price of the services delivered in excess of the costs of execution. In the "negotiation" for services the expected trading volume (or, less often, the cents per share) are adjusted to pay for the expected service.
In my opinion, the third paragraph of the email reveals information about the motivations of SIFMA, the full-service brokerage industry and the (regulated) institutional investment industry. Brokerage commission allocation, commission bugeting, and brokerage commission 'tracking' are done by every sophisticated institutional investment advisory firm. These (currently maintained) records could be made available at little additonal cost. I believe the benefits of better disclosure of the service components in bundled commission arrangements, and about how institutional clients' brokerage commissions are being spent, would translate into a better cost benefit proposition for institutional investment clients.
I also believe that in the face of the rapid growth of Client Commission Arrangements (CCA's) the urgency of institutional brokerage commission disclosure has increased. Without such disclosure excuting brokers in CCA's have very significant competitive advantages over regional brokers, third-party brokers, and independent research providers. I don't believe the SEC saw the potential of such significant competitve advantage when it issued the Goldman Sachs Research Xpress 'no action letter' (January 17, 2007).
* In a world with bundled undisclosed services and opaque commission arrangments such brokerage 'services' might include mutual fund distribution arrangements, wrap account introductions, IPO allocation and the opportunity to flip the IPObefore the end of the stabilization period, late trading arrangements, and special favors to corporations in investment banking arrangements and for 'directed trading" in their retirement and savings plans. In many cases such arrangements do not provide "direct benefit" to the institutional client whose commissions paid for the 'services'.
|
|
