Monday, May 23, 2005
Research Transparency/Soft Dollar Issues
Broker Research: What's It Worth?
Apr 26, 2005
URL: http://www.wallstreetandtech.com/showArticle.jhtml?articleID=161600239
With the Securities and Exchange Commission expected to rule on the use of soft dollars in June, the securities industry is hoping that the SEC will clear up the uncertainties surrounding the controversial practice and determine once and for all who is responsible for placing a value on proprietary research. In anticipation of the ruling - which, at a minimum, likely will result in more transparency into how buy-side firms are spending investors' money - buy-side firms are beefing up their internal controls to track their commission payments for executions versus third-party research.
The challenge, however, is figuring out how much the sell side's research actually is worth. But the SEC may go a step further than just requiring increased transparency into brokerage commissions and force brokerage firms to "unbundle," or break out, the prices they charge for executions, proprietary research and capital commitment individually.
Generally, soft dollars refer to the portion of a brokerage commission paid by money managers that is used to cover third-party research services, such as market data and investment analysis tools. Under section 28 (e) of the Securities and Exchange Act of 1934, known as the safe harbor rule, a manager can "pay up" for a trade - pay more than the lowest price to buy or sell a stock - if the manager believes the research will add value to the investment process. Asset managers must be in compliance with the safe harbor rule to justify soft-dollar transactions.
Today, bulge-bracket firms charge a bundled commission - four, five or six cents a share, for example - that covers the cost of both the execution and proprietary research. If the SEC rules for greater transparency, the buy side will have to come up with a process to value the sell side's research. However, if unbundling is mandated, the burden will shift to the sell side, as it will be required to put a price tag on its proprietary research (which includes research reports, analyst calls and conferences to which brokers have access) before charging its buy-side counterparts. According to industry sources, a mandate to unbundle commissions could reshape the brokerage and money management landscapes.
Prepping for Transparency
Although the outcome of the ruling still is in doubt, most believe the SEC will rule in favor of soft-dollar transparency. As a result, the buy side is scrambling to get technology and processes in place to ensure that it can track trading commissions and come up with a process to value research.
Currently, to calculate their commission budgets, buy-side firms typically conduct what's known as a "broker vote," an internal process in which all of a firm's portfolio managers, analysts and traders qualitatively assess the value of the various services provided by different brokers and decide which firms' services they want to buy. Asset managers may develop their own voting system based on internally developed qualitative factors, using points or a ratings system.
For example, Darren Bodenhamer, head trader at JMP Asset Management, a San Francisco-based hedge fund, relates, "We have a quarterly voting process in which we quantify the value of research and execution from each broker. We're all involved in the process."
To augment the process, buy-side firms are ramping up their systems to help them track executions and value the research and other services they receive from brokers. Bodenhamer notes that his firm purchased Traders Console, an order management system developed by Boston-based Eze Castle Software, to track its commission payments to brokers. The system allows the hedge fund to break out commissions by using labels such as "r" for research, "e" for execution and others, he explains.
Another buy-side firm enhancing its technology in preparation for the SEC's ruling is The Boston Company Asset Management. To make its commission budgeting and allocation process more rigorous, the asset manager implemented Eze Castle's Commission Optimizer. The firm now is in the early stages of tracking and evaluating what it consumes from sell-side research.
"With the regulatory environment moving toward increased disclosure on third-party soft dollars and toward an unbundled structure on proprietary research, we needed to go beyond having an anecdotal, subjective assessment twice a year that didn't integrate the actual interactions we were having with our brokers and their actual inputs we were using from brokers as part of proprietary research," says David Brooks, head trader at The Boston Company Asset Management.
Now, the investment firm uses the commission management system to track all of its interactions with brokers more dynamically, notes Brooks. "We're trying to get a much better handle on what we're consuming and what is the value of what we're consuming," he says. To track the interactions that portfolio managers are having with brokers on a daily basis, assistants enter the data into Commission Optimizer. When a broker introduces the investment firm to a company's management, or a sell-side analyst stops by the firm, or the broker sponsors a conference, or the firm takes away ideas from a conference call, the information is logged into the system. The firm is not yet tracking written research, however, "because the volume of product is too immense to track," says Brooks.
Scrutiny from All Sides
Aside from regulatory pressures, buy-side firms are facing scrutiny from pension fund clients, independent boards of directors and trustees about why they are paying commissions to various brokers and whether they are getting value from the research, according to Donna Anderson, director of research at AIM Investments, a Houston-based mutual fund manager with about $141 billion in assets. "We're not necessarily setting a price on research - we're trying to quantify the value we get from research and we're trying to send it to our internal management and to our own internal board of trustees," she says, adding that "When it comes to firms that have a bundled execution and research product, we need a way to rate the information we're getting as well as the executions we're getting."
As a result, less than a year ago, AIM purchased a system called ResearchTrak from Cogent Consulting to help the firm understand its total commission picture. Prior to implementing the system, under pressure from the mutual fund company's board of trustees, AIM had revamped its voting structure for the purpose of more clearly differentiating its brokers, Anderson relates.
AIM is using its Web-based system to track proprietary research services down to the individual resource level, with the hope of placing a value on brokers and their research. A resource can be a specific analyst, a conference or set of conferences, a specific quantitative tool or a data set, Anderson says. The software provides a detailed menu of resources provided by every brokerage firm. The fund management firm populates the system with the names of all the analysts at every brokerage from a database provided by Starmine - a San Francisco-based company that measures the performance of sell-side analysts - and conducts a vote twice a year. The head of research administers the vote, which includes all the portfolio managers and analysts; the trading group conducts a separate vote on the execution and sales trading relationship.
How Much Is That Research in the Window?
By using the technology to create a more detailed voting process, AIM has been able to place a value of sorts on its brokers and thus on its research. ResearchTrak has allowed AIM to create a scorecard with which to identify brokers' strengths and weakness. The firm communicates to its brokers how individual analysts rank by sector or company versus their peers. This type of feedback is appreciated by brokers and helps asset managers work in partnership with Wall Street firms as it gives the brokers specific tips on how to improve their rankings to compete for more commission dollars.
Money managers use the voting process to set commission targets for each broker, and they may put brokers in different tiers. If the OMS system is feeding trades into the commission management system, a buy-side firm can see where a broker ranks on a commission basis against the targets and compare the broker's commission ranking to its research ranking, which asset managers base on quality or perceived value. "Clients look very closely at the disconnect there," says Robin Hodgkins, president of Summit, N.J.-based Cogent Consulting. "Better-rated brokers should be getting more of your commissions," he says. "If a broker is providing better service, their commission should be going up, and if they're providing worse service, their commission should go down."
Although several buy-side firms have found technology to help them track commissions, and even place relative values on research - certainly a step in the right direction - the biggest challenge still remains: actually placing a price in dollars and cents on the research. Despite buy-side firms' efforts, pinpointing the value of proprietary research remains a conundrum because the sell side doesn't break out the pricing. "The sell side, up until this point, has not been too helpful in providing guidance on these inputs," points out The Boston Company Asset Management's Brooks.
Using buy-side OMS platforms like Traders Console - such as those from OMS providers Charles River Development, Macgregor, Linedata Services and Latent Zero - to record the commissions on each trade, buy-side firms can tag their trades and broadly classify the different groups into buckets, adds David Quinlan, president of Eze Castle. In addition, commission-tracking systems, such as Eze Castle's Commission Optimizer, Financial Sockets' BrokerVote and Cogent's ResearchTrak, enable the buy side to compare actual trading commissions against their soft-dollar targets.
But, while a firm can record that it completed a four-cent trade with a particular broker, of which one cent was for the execution and the other three cents paid the broker for research-related services, the firm can't break down with any granularity for what services the three cents paid. "What's the research worth? That's the piece that's still missing," Quinlan says.
How Will the SEC Rule?
The consensus among industry sources is that the SEC definitely will call for greater transparency regarding soft-dollar spending. But, buy- and sell-side firms are waiting to see if the SEC will place the onus on the sell side by requiring the brokerage community to unbundle its services and disclose the price of its research versus executions.
David Tittleworth, executive director of the Investment Adviser Association (formerly the Investment Counsel Association of America; ICAA), isn't convinced that the SEC will require unbundling. "I think it's appropriate for the brokers to value [research], but I'm not convinced we've won that battle at the SEC," he says.
According to a Bear Stearns report issued in March, "The SEC's most likely action will be to increase disclosure and transparency - while possibly narrowing the definition of soft dollars." But, the report adds, Bear Stearns analysts "believe the SEC is seriously considering further rules regarding unbundling of commissions - or placing value on proprietary research, execution and capital commitment."
"U.S. brokerage firms are in the midst of creating a menu of services," continue Daniel Goldberg and Andrew Lee, the Bear Stearns analysts who authored the report. For example, rather than charge a bundled rate of five cents per share - which includes research, execution and capital commitment, among other services - the brokers soon could be required to break out that five cents per share into two cents for research, 1.5 cents for execution and 1.5 cents for capital commitment, the report says.
Without unbundled pricing, according to Cogent Consulting's Hodgkins, firms "have no decent way to put a value on the research they're getting." For example, "You can have three calls from an analyst on one day - two can be meaningless but the third call can be priceless. How do you price those calls?" he asks. "That's the dilemma in having an a la carte price list for this kind of very subjective research."
The ramifications of unbundling services are huge for sell-side firms since any movement toward unbundling would shake up their business model. "It wouldn't surprise me - with the devaluation of the business model on the sell side - that brokers have already started understanding what their cost structure is in providing the trading services as opposed to research," says John Feng, a consultant at Greenwich Research. He cautions that unbundling will have unintended consequences, however. "Given the decline in the commission pool, the sell side has been rationalizing research," he says, and its research budget has been shrinking. "Brokerage firms have to be realistic about their business and determine which accounts are profitable to serve."
If regulators were to require brokers to unbundle commissions, it could lead to increased use of low-cost algorithmic trading tools by the buy side, resulting in price wars among brokers, note the Bear Stearns analysts. As unbundling of commissions evolves, sell-side firms would be forced to provide a menu of services reflecting a breakdown in the pricing of executions, research and capital commitment so that asset managers could pick the services they want. This could lead money managers to buy less proprietary research and therefore reduce their commission payments to brokers, which could in turn force brokers to slash their research coverage and impair the quality of available proprietary research.
Balancing Act
From the investment managers' point of view, a balance needs to be struck between ensuring that they get good service - including good research coverage and idea flow - while minimizing costs. "Slashing trading costs without being mindful of other repercussions may not be advisable," Greenwich Research's Feng warns. The resulting decline in broker commissions could lead brokers to cut their research budgets further while focusing their efforts on their most profitable clients. This could lead to an overall drop in the quality of research and services available to the buy side.
Still, industry sources assert that brokers' commissions need to be more transparent. "Investors should have an opportunity to see how their commission dollars are spent between execution and research," says The Boston Company Asset Management's Brooks.
"It's a difficult exercise when you talk about taking what historically had been sort of an all-you-can-eat price and turn it into an a la carte model," admits the head trader. "That's why you are seeing a lot of push-back now from the buy side and sell side. It really is a huge structural change," Brooks continues. "It's not a matter of flipping a switch and having those numbers broken out," he adds. "But I do think it's important to get there."
FSA Proposes Rules on Bundled Services and Soft Dollars
On March 31, the Financial Services Authority - the United Kingdom's financial services regulator - published proposed rules to address the lack of transparency and accountability identified in soft commissions and bundled brokerage arrangements. Industry sources speculate that the SEC will at least partly follow the FSA's example.
The FSA's new rules aim to limit investment managers' use of dealing commissions for the purchase of execution and research services; require investment managers to disclose to customers details of how these commission payments will be spent and what services have been acquired with them; and promote a level playing field in the production of research, whether it is produced within investment banks or by third parties.
Under the proposed rules, the FSA spells out the goods and services that fall under the definition of executions and research and details what can be paid for with commissions versus those services that cannot. While the FSA did not definitively say whether market pricing and information services are permitted or non-permitted services, it offers guidelines that investment managers can use to categorize particular goods and services. The FSA's proposed list of non-permitted goods and services includes computer hardware, seminar fees and travel or entertainment costs.
The FSA also proposes new disclosure requirements stating that investment managers will need to supply descriptions of their policies and procedures in the management of trading commissions paid on behalf of clients.
Investment managers will need to give clients specific information on how commissions paid have been generated and how they have been used, including a split between amounts spent on execution and amounts spent on research. "The FSA is asking investment managers to provide clarity on how they come up with those splits, whether it is an assignment of value or whether it's a discussion they have with brokers in which they mutually arrive at a percentage split," says John Feng, consultant at Greenwich Research.
The FSA's consultation paper and proposed rules are available for comment until May 31. Final rules are expected in July 2005.
To download the FSA paper, go to: www.fsa.gov.uk/pubs/cp/cp05_05.pdf
Apr 26, 2005
URL: http://www.wallstreetandtech.com/showArticle.jhtml?articleID=161600239
With the Securities and Exchange Commission expected to rule on the use of soft dollars in June, the securities industry is hoping that the SEC will clear up the uncertainties surrounding the controversial practice and determine once and for all who is responsible for placing a value on proprietary research. In anticipation of the ruling - which, at a minimum, likely will result in more transparency into how buy-side firms are spending investors' money - buy-side firms are beefing up their internal controls to track their commission payments for executions versus third-party research.
The challenge, however, is figuring out how much the sell side's research actually is worth. But the SEC may go a step further than just requiring increased transparency into brokerage commissions and force brokerage firms to "unbundle," or break out, the prices they charge for executions, proprietary research and capital commitment individually.
Generally, soft dollars refer to the portion of a brokerage commission paid by money managers that is used to cover third-party research services, such as market data and investment analysis tools. Under section 28 (e) of the Securities and Exchange Act of 1934, known as the safe harbor rule, a manager can "pay up" for a trade - pay more than the lowest price to buy or sell a stock - if the manager believes the research will add value to the investment process. Asset managers must be in compliance with the safe harbor rule to justify soft-dollar transactions.
Today, bulge-bracket firms charge a bundled commission - four, five or six cents a share, for example - that covers the cost of both the execution and proprietary research. If the SEC rules for greater transparency, the buy side will have to come up with a process to value the sell side's research. However, if unbundling is mandated, the burden will shift to the sell side, as it will be required to put a price tag on its proprietary research (which includes research reports, analyst calls and conferences to which brokers have access) before charging its buy-side counterparts. According to industry sources, a mandate to unbundle commissions could reshape the brokerage and money management landscapes.
Prepping for Transparency
Although the outcome of the ruling still is in doubt, most believe the SEC will rule in favor of soft-dollar transparency. As a result, the buy side is scrambling to get technology and processes in place to ensure that it can track trading commissions and come up with a process to value research.
Currently, to calculate their commission budgets, buy-side firms typically conduct what's known as a "broker vote," an internal process in which all of a firm's portfolio managers, analysts and traders qualitatively assess the value of the various services provided by different brokers and decide which firms' services they want to buy. Asset managers may develop their own voting system based on internally developed qualitative factors, using points or a ratings system.
For example, Darren Bodenhamer, head trader at JMP Asset Management, a San Francisco-based hedge fund, relates, "We have a quarterly voting process in which we quantify the value of research and execution from each broker. We're all involved in the process."
To augment the process, buy-side firms are ramping up their systems to help them track executions and value the research and other services they receive from brokers. Bodenhamer notes that his firm purchased Traders Console, an order management system developed by Boston-based Eze Castle Software, to track its commission payments to brokers. The system allows the hedge fund to break out commissions by using labels such as "r" for research, "e" for execution and others, he explains.
Another buy-side firm enhancing its technology in preparation for the SEC's ruling is The Boston Company Asset Management. To make its commission budgeting and allocation process more rigorous, the asset manager implemented Eze Castle's Commission Optimizer. The firm now is in the early stages of tracking and evaluating what it consumes from sell-side research.
"With the regulatory environment moving toward increased disclosure on third-party soft dollars and toward an unbundled structure on proprietary research, we needed to go beyond having an anecdotal, subjective assessment twice a year that didn't integrate the actual interactions we were having with our brokers and their actual inputs we were using from brokers as part of proprietary research," says David Brooks, head trader at The Boston Company Asset Management.
Now, the investment firm uses the commission management system to track all of its interactions with brokers more dynamically, notes Brooks. "We're trying to get a much better handle on what we're consuming and what is the value of what we're consuming," he says. To track the interactions that portfolio managers are having with brokers on a daily basis, assistants enter the data into Commission Optimizer. When a broker introduces the investment firm to a company's management, or a sell-side analyst stops by the firm, or the broker sponsors a conference, or the firm takes away ideas from a conference call, the information is logged into the system. The firm is not yet tracking written research, however, "because the volume of product is too immense to track," says Brooks.
Scrutiny from All Sides
Aside from regulatory pressures, buy-side firms are facing scrutiny from pension fund clients, independent boards of directors and trustees about why they are paying commissions to various brokers and whether they are getting value from the research, according to Donna Anderson, director of research at AIM Investments, a Houston-based mutual fund manager with about $141 billion in assets. "We're not necessarily setting a price on research - we're trying to quantify the value we get from research and we're trying to send it to our internal management and to our own internal board of trustees," she says, adding that "When it comes to firms that have a bundled execution and research product, we need a way to rate the information we're getting as well as the executions we're getting."
As a result, less than a year ago, AIM purchased a system called ResearchTrak from Cogent Consulting to help the firm understand its total commission picture. Prior to implementing the system, under pressure from the mutual fund company's board of trustees, AIM had revamped its voting structure for the purpose of more clearly differentiating its brokers, Anderson relates.
AIM is using its Web-based system to track proprietary research services down to the individual resource level, with the hope of placing a value on brokers and their research. A resource can be a specific analyst, a conference or set of conferences, a specific quantitative tool or a data set, Anderson says. The software provides a detailed menu of resources provided by every brokerage firm. The fund management firm populates the system with the names of all the analysts at every brokerage from a database provided by Starmine - a San Francisco-based company that measures the performance of sell-side analysts - and conducts a vote twice a year. The head of research administers the vote, which includes all the portfolio managers and analysts; the trading group conducts a separate vote on the execution and sales trading relationship.
How Much Is That Research in the Window?
By using the technology to create a more detailed voting process, AIM has been able to place a value of sorts on its brokers and thus on its research. ResearchTrak has allowed AIM to create a scorecard with which to identify brokers' strengths and weakness. The firm communicates to its brokers how individual analysts rank by sector or company versus their peers. This type of feedback is appreciated by brokers and helps asset managers work in partnership with Wall Street firms as it gives the brokers specific tips on how to improve their rankings to compete for more commission dollars.
Money managers use the voting process to set commission targets for each broker, and they may put brokers in different tiers. If the OMS system is feeding trades into the commission management system, a buy-side firm can see where a broker ranks on a commission basis against the targets and compare the broker's commission ranking to its research ranking, which asset managers base on quality or perceived value. "Clients look very closely at the disconnect there," says Robin Hodgkins, president of Summit, N.J.-based Cogent Consulting. "Better-rated brokers should be getting more of your commissions," he says. "If a broker is providing better service, their commission should be going up, and if they're providing worse service, their commission should go down."
Although several buy-side firms have found technology to help them track commissions, and even place relative values on research - certainly a step in the right direction - the biggest challenge still remains: actually placing a price in dollars and cents on the research. Despite buy-side firms' efforts, pinpointing the value of proprietary research remains a conundrum because the sell side doesn't break out the pricing. "The sell side, up until this point, has not been too helpful in providing guidance on these inputs," points out The Boston Company Asset Management's Brooks.
Using buy-side OMS platforms like Traders Console - such as those from OMS providers Charles River Development, Macgregor, Linedata Services and Latent Zero - to record the commissions on each trade, buy-side firms can tag their trades and broadly classify the different groups into buckets, adds David Quinlan, president of Eze Castle. In addition, commission-tracking systems, such as Eze Castle's Commission Optimizer, Financial Sockets' BrokerVote and Cogent's ResearchTrak, enable the buy side to compare actual trading commissions against their soft-dollar targets.
But, while a firm can record that it completed a four-cent trade with a particular broker, of which one cent was for the execution and the other three cents paid the broker for research-related services, the firm can't break down with any granularity for what services the three cents paid. "What's the research worth? That's the piece that's still missing," Quinlan says.
How Will the SEC Rule?
The consensus among industry sources is that the SEC definitely will call for greater transparency regarding soft-dollar spending. But, buy- and sell-side firms are waiting to see if the SEC will place the onus on the sell side by requiring the brokerage community to unbundle its services and disclose the price of its research versus executions.
David Tittleworth, executive director of the Investment Adviser Association (formerly the Investment Counsel Association of America; ICAA), isn't convinced that the SEC will require unbundling. "I think it's appropriate for the brokers to value [research], but I'm not convinced we've won that battle at the SEC," he says.
According to a Bear Stearns report issued in March, "The SEC's most likely action will be to increase disclosure and transparency - while possibly narrowing the definition of soft dollars." But, the report adds, Bear Stearns analysts "believe the SEC is seriously considering further rules regarding unbundling of commissions - or placing value on proprietary research, execution and capital commitment."
"U.S. brokerage firms are in the midst of creating a menu of services," continue Daniel Goldberg and Andrew Lee, the Bear Stearns analysts who authored the report. For example, rather than charge a bundled rate of five cents per share - which includes research, execution and capital commitment, among other services - the brokers soon could be required to break out that five cents per share into two cents for research, 1.5 cents for execution and 1.5 cents for capital commitment, the report says.
Without unbundled pricing, according to Cogent Consulting's Hodgkins, firms "have no decent way to put a value on the research they're getting." For example, "You can have three calls from an analyst on one day - two can be meaningless but the third call can be priceless. How do you price those calls?" he asks. "That's the dilemma in having an a la carte price list for this kind of very subjective research."
The ramifications of unbundling services are huge for sell-side firms since any movement toward unbundling would shake up their business model. "It wouldn't surprise me - with the devaluation of the business model on the sell side - that brokers have already started understanding what their cost structure is in providing the trading services as opposed to research," says John Feng, a consultant at Greenwich Research. He cautions that unbundling will have unintended consequences, however. "Given the decline in the commission pool, the sell side has been rationalizing research," he says, and its research budget has been shrinking. "Brokerage firms have to be realistic about their business and determine which accounts are profitable to serve."
If regulators were to require brokers to unbundle commissions, it could lead to increased use of low-cost algorithmic trading tools by the buy side, resulting in price wars among brokers, note the Bear Stearns analysts. As unbundling of commissions evolves, sell-side firms would be forced to provide a menu of services reflecting a breakdown in the pricing of executions, research and capital commitment so that asset managers could pick the services they want. This could lead money managers to buy less proprietary research and therefore reduce their commission payments to brokers, which could in turn force brokers to slash their research coverage and impair the quality of available proprietary research.
Balancing Act
From the investment managers' point of view, a balance needs to be struck between ensuring that they get good service - including good research coverage and idea flow - while minimizing costs. "Slashing trading costs without being mindful of other repercussions may not be advisable," Greenwich Research's Feng warns. The resulting decline in broker commissions could lead brokers to cut their research budgets further while focusing their efforts on their most profitable clients. This could lead to an overall drop in the quality of research and services available to the buy side.
Still, industry sources assert that brokers' commissions need to be more transparent. "Investors should have an opportunity to see how their commission dollars are spent between execution and research," says The Boston Company Asset Management's Brooks.
"It's a difficult exercise when you talk about taking what historically had been sort of an all-you-can-eat price and turn it into an a la carte model," admits the head trader. "That's why you are seeing a lot of push-back now from the buy side and sell side. It really is a huge structural change," Brooks continues. "It's not a matter of flipping a switch and having those numbers broken out," he adds. "But I do think it's important to get there."
FSA Proposes Rules on Bundled Services and Soft Dollars
On March 31, the Financial Services Authority - the United Kingdom's financial services regulator - published proposed rules to address the lack of transparency and accountability identified in soft commissions and bundled brokerage arrangements. Industry sources speculate that the SEC will at least partly follow the FSA's example.
The FSA's new rules aim to limit investment managers' use of dealing commissions for the purchase of execution and research services; require investment managers to disclose to customers details of how these commission payments will be spent and what services have been acquired with them; and promote a level playing field in the production of research, whether it is produced within investment banks or by third parties.
Under the proposed rules, the FSA spells out the goods and services that fall under the definition of executions and research and details what can be paid for with commissions versus those services that cannot. While the FSA did not definitively say whether market pricing and information services are permitted or non-permitted services, it offers guidelines that investment managers can use to categorize particular goods and services. The FSA's proposed list of non-permitted goods and services includes computer hardware, seminar fees and travel or entertainment costs.
The FSA also proposes new disclosure requirements stating that investment managers will need to supply descriptions of their policies and procedures in the management of trading commissions paid on behalf of clients.
Investment managers will need to give clients specific information on how commissions paid have been generated and how they have been used, including a split between amounts spent on execution and amounts spent on research. "The FSA is asking investment managers to provide clarity on how they come up with those splits, whether it is an assignment of value or whether it's a discussion they have with brokers in which they mutually arrive at a percentage split," says John Feng, consultant at Greenwich Research.
The FSA's consultation paper and proposed rules are available for comment until May 31. Final rules are expected in July 2005.
To download the FSA paper, go to: www.fsa.gov.uk/pubs/cp/cp05_05.pdf
Friday, May 20, 2005
3 HFs Get SEC Action on Illegal Shorts
SEC sues and fines 3 hedge funds
Agency claims illegal short sales before share offerings
By Alistair Barr, MarketWatch
Last Update: 11:57 AM ET May 19, 2005
SAN FRANCISCO (MarketWatch) - The Securities and Exchange Commission sued and fined three hedge funds for illegally short-selling shares of several companies before secondary offerings.
Galleon Management LP, Oaktree Capital Management LLC and DB Investment Managers Inc., a unit of Deutsche Bank, were sued for breaking an anti-manipulation rule and agreed to pay a total of almost $2.4 million in disgorged profits, penalties and interest, the SEC said in a statement Thursday.
Deutsche Bank (DB: news, chart, profile) shares declined 2.5% to $77.60 in late morning trading Thursday.
In a short sale traders sell borrowed securities, hoping to buy them back later at a lower price. They then return the securities to the lender at the original price, pocketing the difference.
Short-selling is a legal and important part of securities markets. However, when short sales undermine the integrity of capital-raising efforts such as secondary, or follow-on, share offerings, they can be illegal.
A short sale is illegal when it's covered with securities obtained in a follow-on share sale if the short trade occurred five days before the pricing of that offering, the SEC said.
Enforcing this "is an important way to protect the integrity of the public offering process and to discourage activities that could unfairly influence the market for an offered security," Peter Bresnan, an associate director in the SEC's Division of Enforcement, said.
Shareholders of the company issuing more shares suffer from this type of illegal short-selling because it can artificially depress prices before an offering, Bersnan added.
Companies are also short-changed by the practice because it may cut the valuation of a follow-on offering, ultimately reducing "an issuer's proceeds from the deal by millions of dollars," the SEC said.
Galleon, Oaktree and DB Investment Managers illegally sold stock short before secondary share sales by 22 companies, the SEC alleged.
The three hedge funds made $1,040,882, $169,773 and $15,585 respectively from the trades, the agency added.
Galleon and Oaktree also created "sham" transactions to make it look like they were trading within the rules, the SEC claimed.
The funds built up large short positions within the restricted period, purchased shares in a follow-on offering and then "engaged in further transactions or trading practices" to make it look like the deal complied with the rules, the agency explained.
The three funds didn't admit or deny the allegations.
Agency claims illegal short sales before share offerings
By Alistair Barr, MarketWatch
Last Update: 11:57 AM ET May 19, 2005
SAN FRANCISCO (MarketWatch) - The Securities and Exchange Commission sued and fined three hedge funds for illegally short-selling shares of several companies before secondary offerings.
Galleon Management LP, Oaktree Capital Management LLC and DB Investment Managers Inc., a unit of Deutsche Bank, were sued for breaking an anti-manipulation rule and agreed to pay a total of almost $2.4 million in disgorged profits, penalties and interest, the SEC said in a statement Thursday.
Deutsche Bank (DB: news, chart, profile) shares declined 2.5% to $77.60 in late morning trading Thursday.
In a short sale traders sell borrowed securities, hoping to buy them back later at a lower price. They then return the securities to the lender at the original price, pocketing the difference.
Short-selling is a legal and important part of securities markets. However, when short sales undermine the integrity of capital-raising efforts such as secondary, or follow-on, share offerings, they can be illegal.
A short sale is illegal when it's covered with securities obtained in a follow-on share sale if the short trade occurred five days before the pricing of that offering, the SEC said.
Enforcing this "is an important way to protect the integrity of the public offering process and to discourage activities that could unfairly influence the market for an offered security," Peter Bresnan, an associate director in the SEC's Division of Enforcement, said.
Shareholders of the company issuing more shares suffer from this type of illegal short-selling because it can artificially depress prices before an offering, Bersnan added.
Companies are also short-changed by the practice because it may cut the valuation of a follow-on offering, ultimately reducing "an issuer's proceeds from the deal by millions of dollars," the SEC said.
Galleon, Oaktree and DB Investment Managers illegally sold stock short before secondary share sales by 22 companies, the SEC alleged.
The three hedge funds made $1,040,882, $169,773 and $15,585 respectively from the trades, the agency added.
Galleon and Oaktree also created "sham" transactions to make it look like they were trading within the rules, the SEC claimed.
The funds built up large short positions within the restricted period, purchased shares in a follow-on offering and then "engaged in further transactions or trading practices" to make it look like the deal complied with the rules, the agency explained.
The three funds didn't admit or deny the allegations.
EU Commission Eyes HF Regulation
EU Commission eyes hedge fund regulation
IPE.com 20/May/05: EUROPE – The European Commissioner in change of the internal market, Charlie McCreevy, has identified the “patchwork quilt” of hedge fund regulation in Europe as something that needs to be looked at.
McCreevy told an audience in Dublin that there is currently no common regulatory approach to hedge funds within the European Union.
He said: “Many national regulators have however responded individually which in turn has given rise to something of a patchwork quilt of rules across the member states.
“The extent to which this might limit the future efficient development of the alternative investment market is something that needs to be explored.
“We need to see if at EU level we can facilitate the development of this sector in a way that stimulates greater efficiency for operators.”
Speaking at the Annual Global Funds Conference hosted by the Dublin Funds Industry Association and the National Investment Company Service Association, he also expressed concern over investor protection and the possible economic impact of hedge funds.
He said: “Regulators examining these changes in the landscape are focused specifically on the potential implications for unwary investors and for the possible impact of some of the investment and trading strategies in a macroeconomic context.”
But he said the Commission would try to keep a balance. “We don’t want to end up with rules that place excessive restrictions on financial innovation or that smother the market’s ability to efficiently meet real investor needs.”
The London-based Centre for Economics and Business Research yesterday likened investing in hedge funds to betting on horses, according to a Reuters news report.
IPE.com 20/May/05: EUROPE – The European Commissioner in change of the internal market, Charlie McCreevy, has identified the “patchwork quilt” of hedge fund regulation in Europe as something that needs to be looked at.
McCreevy told an audience in Dublin that there is currently no common regulatory approach to hedge funds within the European Union.
He said: “Many national regulators have however responded individually which in turn has given rise to something of a patchwork quilt of rules across the member states.
“The extent to which this might limit the future efficient development of the alternative investment market is something that needs to be explored.
“We need to see if at EU level we can facilitate the development of this sector in a way that stimulates greater efficiency for operators.”
Speaking at the Annual Global Funds Conference hosted by the Dublin Funds Industry Association and the National Investment Company Service Association, he also expressed concern over investor protection and the possible economic impact of hedge funds.
He said: “Regulators examining these changes in the landscape are focused specifically on the potential implications for unwary investors and for the possible impact of some of the investment and trading strategies in a macroeconomic context.”
But he said the Commission would try to keep a balance. “We don’t want to end up with rules that place excessive restrictions on financial innovation or that smother the market’s ability to efficiently meet real investor needs.”
The London-based Centre for Economics and Business Research yesterday likened investing in hedge funds to betting on horses, according to a Reuters news report.
Wednesday, May 18, 2005
Another SEC PIPEs Enforcement Case
--------------------------------------------------------------------------------
Printed from NewYorkBusiness.com
--------------------------------------------------------------------------------
Hedge fund manager fined for insider trading
May 18, 2005
A former hedge fund manager for First New York Securities was ordered to pay $1.45 million to settle fraud and insider trading charges by the National Association of Securities Dealers and the Securities and Exchange Commission related to a private placement transaction.
NASD permanently barred the manager, Hilary Shane, from working with any of its registered firms, while the SEC suspended her for one year from the investment advisory business.
Regulators charged Ms. Shane with insider trading, saying she sold short Compudyne Corp. stock in 2001 before the public announcement of a private investment in public equity, or PIPE, transaction that raised more than $29 million. Regulators said Ms. Shane, who did not admit any wrongdoing, made $1.13 million from the illegal activity.
PIPE shares need to be registered with the SEC before investors can sell them on the open market.
--------------------------------------------------------------------------------
Printed from NewYorkBusiness.com
--------------------------------------------------------------------------------
Hedge fund manager fined for insider trading
May 18, 2005
A former hedge fund manager for First New York Securities was ordered to pay $1.45 million to settle fraud and insider trading charges by the National Association of Securities Dealers and the Securities and Exchange Commission related to a private placement transaction.
NASD permanently barred the manager, Hilary Shane, from working with any of its registered firms, while the SEC suspended her for one year from the investment advisory business.
Regulators charged Ms. Shane with insider trading, saying she sold short Compudyne Corp. stock in 2001 before the public announcement of a private investment in public equity, or PIPE, transaction that raised more than $29 million. Regulators said Ms. Shane, who did not admit any wrongdoing, made $1.13 million from the illegal activity.
PIPE shares need to be registered with the SEC before investors can sell them on the open market.
--------------------------------------------------------------------------------
Saturday, May 07, 2005
Greenspan on HF Regulation
Greenspan: Giving Hedge Funds New Rules Won't Work
Friday, May 6, 2005
By Barbara A. Rehm and Rob Blackwell
CHICAGO - Federal Reserve Board Chairman Alan Greenspan warned bankers Thursday to demand more of their hedge fund customers, while U.S. Bancorp chairman Jerry Grundhofer warned against following nonbanks down a slippery slope to a pile of problem credits.
Mr. Grundhofer said competition for commercial credits is fierce, with hedge funds and other nonbank lenders making pricing irrational.
"There is margin compression everywhere," he said in a luncheon speech at the Federal Reserve Bank of Chicago's annual Conference on Bank Structure and Competition.
U.S. Bancorp accepts that and attempts to make up for lower rates with higher volume, he said, but that's "a tough call, a tough line to walk." U.S. Bancorp is trying not to "reach too far for marginal credit." But some nonbank rivals, including hedge funds, are not as disciplined, he said.
"Overall credit standards have deteriorated. Certainly pricing has, and we're starting to see problems with structure as well," he said in an interview after his speech. "They may be the smartest underwriters on Earth," he said of hedge funds. "We'll see who's right and who is wrong."
U.S. Bancorp is "trying to be aggressive on pricing, and get new business, but not fool around with" changes in loan terms and conditions, he said.
Mr. Greenspan said that banks had made "considerable progress" in strengthening oversight of their relationships with hedge funds since the fall of Long-Term Capital Management in 1998.
But he said a recent central bank study of banks' management of hedge fund credit risk found several "weaknesses."
"Competitive pressures may be eroding the protection that banks achieve through collateral requirements by reducing the initial margins that they obtain from hedge funds," Mr. Greenspan said. "The review suggests that banks and their supervisors need to be alert to the possibility that further slippage of credit terms could result in material increases in credit risk to banks, a material loss of market discipline on hedge funds, and a material increase in the potential for hedge fund leverage to adversely affect market dynamics."
Mr. Greenspan urged bankers to persuade hedge fund managers to provide more information about their portfolios, including "forward-looking measures of the risks that the funds are assuming."
"Most banks' policies," he said, "could be improved by the establishment of clearer and firmer links between credit terms and transparency."
Mr. Greenspan also urged bankers to aggregate stress-test results across hedge fund counterparties "to assess concentrations of exposures in volatile and illiquid markets."
However, Mr. Greenspan said he opposes ramping up regulation of hedge funds. Any additional disclosure requirements would be fruitless. "Most of the data would tell you their strategy of last night. This morning they would have a new one. It's their very nature to be innovative and ever-changing," he said during a question-and-answer session.
Speaking on other risks to the financial system, Mr. Greenspan said concerns that credit derivatives have transferred too much risk outside the banking system appear to be overblown.
There were $4.5 trillion of the derivatives as of June, and some experts have become concerned that losses to nonbank risk-takers could force them to liquidate their positions if credit spreads widen appreciably.
But Mr. Greenspan cited a study conducted last year by the Joint Forum that said the notional values of derivatives had "significantly overstated the amount of credit risk that had been transferred outside the banking system."
Mr. Greenspan also reiterated his position that the mortgage portfolios of Fannie Mae and Freddie Mac should be reduced.
But instead of recommending specific caps, as he has done in the past, Mr. Greenspan said he agreed with Treasury Secretary John Snow's recommendation that a proposed new regulator for the GSEs have power over the portfolios and get specific guidance from Congress on how to treat them.
"Specifically, the GSE should hold only the minimum level of assets needed to accomplish the primary missions mandated by their charter," Mr. Greenspan said.
© 2005 American Banker and SourceMedia, Inc. All rights reserved.
Friday, May 6, 2005
By Barbara A. Rehm and Rob Blackwell
CHICAGO - Federal Reserve Board Chairman Alan Greenspan warned bankers Thursday to demand more of their hedge fund customers, while U.S. Bancorp chairman Jerry Grundhofer warned against following nonbanks down a slippery slope to a pile of problem credits.
Mr. Grundhofer said competition for commercial credits is fierce, with hedge funds and other nonbank lenders making pricing irrational.
"There is margin compression everywhere," he said in a luncheon speech at the Federal Reserve Bank of Chicago's annual Conference on Bank Structure and Competition.
U.S. Bancorp accepts that and attempts to make up for lower rates with higher volume, he said, but that's "a tough call, a tough line to walk." U.S. Bancorp is trying not to "reach too far for marginal credit." But some nonbank rivals, including hedge funds, are not as disciplined, he said.
"Overall credit standards have deteriorated. Certainly pricing has, and we're starting to see problems with structure as well," he said in an interview after his speech. "They may be the smartest underwriters on Earth," he said of hedge funds. "We'll see who's right and who is wrong."
U.S. Bancorp is "trying to be aggressive on pricing, and get new business, but not fool around with" changes in loan terms and conditions, he said.
Mr. Greenspan said that banks had made "considerable progress" in strengthening oversight of their relationships with hedge funds since the fall of Long-Term Capital Management in 1998.
But he said a recent central bank study of banks' management of hedge fund credit risk found several "weaknesses."
"Competitive pressures may be eroding the protection that banks achieve through collateral requirements by reducing the initial margins that they obtain from hedge funds," Mr. Greenspan said. "The review suggests that banks and their supervisors need to be alert to the possibility that further slippage of credit terms could result in material increases in credit risk to banks, a material loss of market discipline on hedge funds, and a material increase in the potential for hedge fund leverage to adversely affect market dynamics."
Mr. Greenspan urged bankers to persuade hedge fund managers to provide more information about their portfolios, including "forward-looking measures of the risks that the funds are assuming."
"Most banks' policies," he said, "could be improved by the establishment of clearer and firmer links between credit terms and transparency."
Mr. Greenspan also urged bankers to aggregate stress-test results across hedge fund counterparties "to assess concentrations of exposures in volatile and illiquid markets."
However, Mr. Greenspan said he opposes ramping up regulation of hedge funds. Any additional disclosure requirements would be fruitless. "Most of the data would tell you their strategy of last night. This morning they would have a new one. It's their very nature to be innovative and ever-changing," he said during a question-and-answer session.
Speaking on other risks to the financial system, Mr. Greenspan said concerns that credit derivatives have transferred too much risk outside the banking system appear to be overblown.
There were $4.5 trillion of the derivatives as of June, and some experts have become concerned that losses to nonbank risk-takers could force them to liquidate their positions if credit spreads widen appreciably.
But Mr. Greenspan cited a study conducted last year by the Joint Forum that said the notional values of derivatives had "significantly overstated the amount of credit risk that had been transferred outside the banking system."
Mr. Greenspan also reiterated his position that the mortgage portfolios of Fannie Mae and Freddie Mac should be reduced.
But instead of recommending specific caps, as he has done in the past, Mr. Greenspan said he agreed with Treasury Secretary John Snow's recommendation that a proposed new regulator for the GSEs have power over the portfolios and get specific guidance from Congress on how to treat them.
"Specifically, the GSE should hold only the minimum level of assets needed to accomplish the primary missions mandated by their charter," Mr. Greenspan said.
© 2005 American Banker and SourceMedia, Inc. All rights reserved.
