Research Commissions: Endangered Species?

February 5th, 2014

Nearly two-thirds of European buy-side firms anticipate research eventually will be paid for from management fees not from client commissions, according to a recent TABB Group survey.  European asset managers spent less money on brokerage research and trading in 2013 relative to market volumes.  A separate survey of U.S. buy-side firms showed a rising share of CSA commissions going to research while the execution portions fell.

Extinction of research commissions?

TABB Group found that 64% of European head traders expect commissions will be paid for from management fees in the future.  According to TABB: “Greater transparency in the research process will finally break the relationship between turnover of assets under management and the generation of research, not only impacting the total commissions paid, but fundamentally altering how research is bought, accessed and consumed, redefining the fragile ecosystem between buy and sell sides in the process.”

Will Commissions Be Paid for from Management Fees in the Future?

Source: TABB Group

TABB Group spoke with 58 head traders of equity management firms across Europe, the UK and US. These firms comprise 49 long-only asset management firms and nine hedge funds, managing €14.6 trillion in assets under management (AUM). The interviews were conducted during Q4 2013.

TABB Group foresees liquidity issues arising from a regulatory push to unbundle. Fewer asset managers will have the wherewithal to purchase brokerage research, resulting in consolidation and reduced liquidity for mid-cap and small-cap stocks:  “The ongoing concentration by both the buy and sell side will continue to propel equity trading to major industrialization, and the ability to access small- and mid-cap names looks set to become limited to an exclusive club of brokers and asset managers.”

Declining research commissions

Meanwhile, research commissions are getting squeezed.  The survey found that European asset managers are allocating a lower portion of trades to high touch research commissions relative to electronic trading.  While average daily equity market volume rose 16% year on year, commissions paid to brokerages climbed just 9%.

More than half of the participants cite traditional brokerage services as having the greatest value, yet just 4% anticipate increasing their order flow allocation to sales trading in 2014, with the majority increasing electronic trading.  Survey respondents projected a 25% decline in allocations to sales trading in 2014 while allocations to direct market access or algorithmic trading were seen increasing by 52%.  As the survey’s author, Rebecca Healey, put it, “Commissions for our sample set may have risen by 9 percent in 2013 after 2012′s dramatic decline of 27 percent, but the reality is that any upturn is unlikely to continue.”


As a result, the research market is becoming more niche-oriented.  In its European survey, TABB found that smaller regional brokers were holding their own: “For European-based asset managers that are struggling with depleted commissions to maintain their relevance to a resource-strapped sell side, the response has been to return to local brokers in their search for valuable quality coverage.”  This trend was particularly apparent in emerging European stocks: “Seventy-eight percent of participants now regularly trade emerging European stocks, and actively look to trade local stock where possible, enabling local brokers to retake market share.”


In a separate study of U.S. buy-side equity managers, TABB found that Commission Sharing Agreements are being used more aggressively in the declining commission environment.   The research portion of the CSA increased from 1.9¢ in 2012 to 2.3¢ in 2013 while the execution component fell from .9¢ to .8¢.   TABB believes this helps asset managers route more trades electronically.

Thus, the use of electronic trading does not have as much of an impact on the total commission pool, since bellwether buy-side firms are more comfortable increasing the research component of a low-touch trade. TABB believes this trend will spread and that the rate differential between high touch and low touch will continue to narrow. As a result, it raises the ceiling on low-touch market share that once existed.


Whether research commissions are headed for extinction, they are certainly under pressure.  TABB’s surveys show that European asset managers are bearish on the future of research commissions, while shrinking their allocations relative to electronic trading.  U.S. asset managers may be less dire in their views, but are also using CSAs to stretch research commissions further, ultimately increasing the electronic share according to TABB.

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Wall Street Jobs Outlook Improves Modestly

February 3rd, 2014

While most experts believe that job opportunities on Wall Street are likely to increase in 2014, they also agree that the financial services employment outlook is unlikely to approach the go-go environment seen before the financial crisis any time soon.

Outlook Improves A Bit

According to Glassdoor, an online career and jobs site, 41% of current employees working in the finance industry believe their company’s business outlook will get better in the next six months (average for all industries).  This compares to 22% of financial industry workers who believe business conditions at their employers would worsen in 2014.

Two types of firms likely to be staffing up this year include private equity and asset management firms as Wall Street veterans set up their own shops.  Unfortunately, most of these firms are small in comparison to Wall Street’s investment banks which are faced with conflicting trends which could keep a lid on hiring at these firms.

Some experts suggest that another bright spot for hiring this year could be the Mergers and Acquisition groups at both large and boutique investment banks.  Sanford Bernstein projects that mergers and acquisitions will rise by 7% in 2014, led by corporate tie-ups in the health care, financial services and technology industries.

Another area where banks are expected to be hiring this year are in the compliance and risk management departments as increased government regulation forces investment banks to beef up these capabilities.

John Challenger, CEO of global outplacement firm Challenger, Gray & Christmas explains this trend at Wall Street banks, “Because of the regulations, they are adding to audit, risk control and risk management, and on the financial reporting side.  Today, they are so scrutinized and there are so many regulations that they have to adhere to, the financial services need mass staffs to comply with all that.”

Some Trends Keep A Lid On Hiring

Of course, increased government regulations like the Volker Rule or increased capital requirements for banks are forcing Wall Street firms to limit their risk taking – a move that will hinder growth and resulting hiring plans.

For example, one area which is unlike to see much hiring in the near-term are investment bank’s fixed-income, currency and commodities trading divisions — an area where most big banks made a lot of their profits during the housing-bubble years.  This area of the bank will be most negatively impacted by the Volcker Rule which goes into full effect in 2015.  Well-known Sanford Bernstein financial services analyst, Brad Hintz acknowledges that “fixed-income remains the problem child,” for most investment banks.

As we have mentioned many times in the past, equity commissions have not really bounced back in the past few years, even though the stock market has rebounded strongly.  Clearly, a continuation of this trend would hamper hiring plans in the equities divisions of most banks.

In addition, many Wall Street firms continue to feel the pressure to cut expenses as weakness in mortgage applications has hampered a major money maker for these banks as interest rates creep higher.

Employment Remains Below Peak Levels

Despite the modest pick-up in hiring that is expected in 2014, few anticipate that Wall Street employment will eclipse the peak levels seen pre-crisis. For example, only about a quarter of the more than 30,000 securities-industry jobs that disappeared from New York after the financial crisis have returned as many firms moved certain roles to lower cost centers in the South or Western US.

Of course, the real driver of Wall Street employment and compensation in 2014 will be the profitability of the industry as it tries to deal with regulatory changes, rising interest rates, and potential legal costs stemming from the financial crisis.

As long as these headwinds remain, most expect that hiring on Wall Street is likely to remain restrained as managers await clear signs of improved business conditions before significantly adding to their payrolls.


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New Idea-Sharing Platform Targets Retail

January 29th, 2014

Interactive Buyside LLC, is a recent platform for buy side analysts to share their research ideas with the goal of attracting new investors.  Although Interactive Buyside has some distance to go before it challenges existing platforms, its entry reflects the growing acceptance and use of crowd-sourced research.

The Interactive Buyside platform is still new.  Its first report was posted in November 2013 and new reports are averaging 3-4 reports per month.  Founder Sam Madden says he has enlisted around 200 buy side professionals to contribute and is targeting a rate of 1-2 reports per week.  He concentrates on smaller asset managers looking to market their capabilities.

Individual investors can sign up for free to view the site’s reports.  In addition, Interactive Buyside has agreements with distributors such as Investor’s Business Daily and Google Finance to distribute reports.  Madden, who previously worked at Highland Capital as well as running his own long/short equity fund, plans to expand content to include market research and industry analysis.

Meanwhile, Seeking Alpha has close to 3 million members, claims over 7,000 contributing authors and covers 3,000 stocks. It says 44% of its contributors are investment professionals; 12% are industry professionals; 9% are management consultants or accountants; and 31% are individual investors.

Among its nearly 3 million registered users, it has approximately 35,000 hedge fund professionals, 25,000 mutual fund professionals, and 22,000 other buyside professionals, along with around 79,000 financial advisors, representing in total about 5.5% of its registered users.

Seeking Alpha makes money through advertising and through subscriptions to SA PRO which provides exclusive early access to its best ideas and to its best small- and mid-cap research.  Seeking Alpha pays out over $250,000 per month to contributors of premium content.  It received a $7 million Series B capital infusion at the end of 2009.

SumZero is a network of over 9000 buy-side investment professionals which makes money through subscriptions, recruiting and capital introductions.  SumZero Elite is a premium subscription service which allows individual investors to receive two ideas a month (of SumZero’s choosing) and participation in discussions with buyside members.  The platform also has buyside job postings and offers a capital introduction service for asset owners to screen on its database of funds seeking new investments.

SumZero is funded by Winklevoss Capital (SumZero’s founder, Divya Narendra, was an ally of the Winklevoss twins in their early struggles with Zuckerberg at Harvard).  Sources indicate that SumZero has been successful in attracting users but is not yet making a profit.

In an earlier blog, we cited academic research which suggested that value for networked investment research decreases as networks become more broad-based.  However a study of SumZero’s recommendations submitted from March 2008 to December 31, 2010 found that overall recommendations had positive returns over a 60-day window after posting while non-consensus ideas earned very meaningful returns.

SumZero buy recommendations on stocks with IBES consensus hold or sell recommendations earned cumulative abnormal returns of 3.2% in the 10-60 day window after posting, while non-consensus short ideas earned 7%.

Interactive Buyside has a long way to go before it rivals either Seeking Alpha or SumZero, but its advent suggests that there is room for additional growth for crowd-sourced research.

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HAL 9000 Comes To Investment Research

January 27th, 2014

In 2001: A Space Odyssey, a sentient computer stars as one of the scariest screen villains of all time eventually forcing the crew of the Discovery One spacecraft to shut down the computer.  However, last week, Kensho, a tech start-up received funding from several VCs to build the research industries’ own version of HAL called Warren, capable of answering millions questions about the impact of global events on asset prices.

Start-up Receives Funding

Last week, Kensho, a Cambridge Massachusetts based start-up secured $10 million in seed funding from General Catalyst, NEA, Accel Partners, Google Ventures, Devonshire Investors (the private equity arm of Fidelity Investments), and several other VCs.

The purpose of this investment was to fund Kensho’s development of “Warren”, a cloud-based virtual market research assistant currently capable of answering one million distinct natural language questions about the impact of global events on asset prices.  The firm expects that Warren will be capable of answering 10 million complex financial questions by the end of 2014.

Warren has been built by software engineers from Google and Apple, including one of the original engineers on the first iPhone team.  Warren has been in beta test with a few hundred analysts at a select group of asset managers for the past four months.

Revolution in Investment Research

Kensho designed Warren to shorten the traditional buy-side investment research cycle from a few hours or even days to minutes.

Daniel Nadler, the CEO of Kensho explained the development of Warren, “Kensho is dedicated to the idea that communicating in natural language with intelligent computer systems which serve as virtual personal assistants will form the leading edge of global innovation over the next half-decade, and will transform not just the consumer space, but industries from medicine and finance to energy and defense as well.”

Warren can currently answer sophisticated investment related questions asked by analysts who have no technical expertise whatsoever, such as:

“What happens to the share prices of energy companies when oil trades above $100 a barrel and political unrest has recently occurred in the Middle East?”, or

“What happens to Home Depot, home builder stocks, and cement company share prices following Category 4 hurricane landfalls in the continental U.S.?”

Stanley Young, the former CEO of Bloomberg Enterprise and a Kensho advisory board member, explained one of the major benefits of Warren, “Millions of hours now wasted on spreadsheet manipulations will be saved, and the high-priced professionals currently mired in those tasks will be freed to dive straight into the high-value endeavor of asking important questions and finding needed answers.”

To create Warren, Kensho says it has built one of the largest unstructured geopolitical and natural world event databases outside the intelligence community.

Dr. James Shinn, the former National Intelligence Officer for Asia at the Central Intelligence Agency and the former Assistant Secretary for Asia in the U.S. Department of Defense, has also joined Kensho’s Advisory Board to help the company with this effort.

Dr. Shinn acknowledged, “Event-driven statistical analysis is a remarkably powerful lens through which to understand the world. The effects of geopolitical events on assets — such as oil prices, currencies, and foreign and domestic equity volatility — is one of the least understood areas and, without technology, is one of the hardest, human-labor intensive, and costliest things to measure, despite clearly having massive effects on these markets.”

Warren Gets Smarter

Besides the speed of analysis provided by the system, Warren has been designed to get smarter the longer it is used by a client.  Nadler explains, “Once you get the systems going, it becomes self-learning.”

After being used by several hundred users over the past 4 months, over fifty thousand distinctly new questions have been added every week, making the system smarter and smarter. “That’s the difference between cloud-based systems and classic hardware on desktops – the smartest it will ever be is the day you bought it. Cloud-based intelligence systems get smarter as users use it and ask questions,” Nadler explains.

NASDAQ Platform Adds Missing Part

Some of the more complex tasks required to build Warren were the security and compliance issues associated with the storage and access of market data facing financial services users.

Fortunately, Kensho did not have to solve this problem alone as it built its research and analytics platform on NASDAQ OMX FinQloud, a cloud computing platform designed exclusively for the financial services sector.

Nadler explains the rationale behind this partnership, “Building a virtual market research assistant who you can talk investment ideas over with, and to whom you can express complicated, multi-conditional questions that draw on both structured and unstructured data (from the history of all asset prices to encyclopedias of global events) constitutes one of the most significant engineering challenges in the history of financial technology” Nadler said. “It will require that an intelligent computer system read millions of pages of natural language documents and have total recall of petabytes of financial data, analyzing the cross-implications in a matter of seconds. Computing these massive datasets in near real-time, and performing split-second investment analysis by searching for correlations between unstructured and structured data is extremely computationally intensive, and will require sophisticated distributed computing environments. In overcoming this colossal technical challenge we are pleased to continue our deep relationship with NASDAQ OMX FinQloud, which augments our cloud-computing infrastructure with the additional financial technology necessary to meet the very specific security and regulatory obligations of financial services.”

Another benefit of using the FinQloud platform is that a client can securely plug-in their own proprietary data into the system, which will only be accessible to their queries.  This data, in combination with the standard asset and pricing data available to everyone using the system, will enable the client to conduct more detailed analysis in their specific areas of interest.  This will motivate buy-side clients to continue gathering unique proprietary data that will better inform their own investment research process.

Warren’s Rollout

Kensho has managed the roll-out of Warren in a gradual manner by inviting and/or accepting firms to be beta users, who contribute their feedback and their research queries to the cloud computing platform.  However, the firm has not released a date for an official commercial roll-out of the system.

Currently, investment professionals interested in participating in Kensho’s beta program for Warren can do so by applying at their website (  However, it is clear from the site that the number of investment professionals who will be included in this beta will be limited.


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Two Visions for the Future of Research

January 22nd, 2014

Two recent pieces titled “The Future of Equity Research” present differing perspectives on forces shaping equity research.  From London comes a white paper examining how potential regulatory changes might alter the research landscape.  Meanwhile, a U.S. industry consultant predicts technological transformation of the research process with the advent of big data analytics.  Both visions speak to significant change ahead for the consumers and providers of equity research.

Regulatory Change

Edison Investment Research, a London-based issuer-paid research provider, teamed with Frost Consulting, a consulting firm specializing in commission unbundling, to produce a 60-page white paper on the potential impacts of proposed UK regulation on equity research.  UK regulators are proposing to restrict commission payments for corporate access and other primary research, and are considering, along with European regulators, a wider ban on commission payments for research.   The paper looks at how research might be impacted by these changes.

Even without the pending regulatory changes, there have already been significant alterations in the research landscape.  Frost estimates that there has been a 43% reduction in global commissions for equity research from 2007 to 2012.  Frost shows a 29% decline in the US, a 48% decline in Japan/Asia/Emerging Markets and a 58% decline in Europe during the period.  At the same time, investment banks have reduced their spending on research (i.e., costs relating to analysts) from over $8 billion to under $5 billion, according to Frost.

Frost Consulting estimates that if asset managers were to absorb the expense that investment banks currently pay for research, it would halve their operating profits.  This is not a likely scenario since it assumes regulators would rescind the ability to pay for research with client commissions on a global basis, and that asset managers would replicate investment bank research internally.  Nevertheless, it illustrates the stakes involved.

Increased regulatory pressure on the use of client commissions for research, when combined with a more hostile market environment, would lead to tectonic changes in equity research, according to Frost and Edison.  The paper posits that investment bank research will move from an unpriced to a priced environment, and banks will become ‘nichier’ by investing in the sectors and geographies which are profitable, while cutting marginally profitable coverage.  Consolidation will continue.

Independent research would benefit from the unbundling of bank research, and asset managers would draw from an increasing diversity of research sources.  The environment would encourage research aggregators—the paper cites Gerson Lehrman Group as one example.  Research distribution would shift from push to pull, fostering more initiatives like RIXML and applications that facilitate selective parsing of research.

As a successful practitioner of the issuer-paid model, Edison Investment Research views prospective regulatory change as positive for its business model, especially when combined with an increased appetite on the part of securities exchanges to facilitate payment for research on under-covered companies.

Technological Change

TABB Group, an industry consulting firm specializing in capital markets, highlights the technological transformation of the research process with the advent of big data analytics.  As with the London white paper, TABB notes that shrinking commissions and increased regulatory scrutiny have reduced research resources.

The role of the sell side analysts has shrunk to providing management access and “handicapping quarterly results” while coverage is limited to underwriting clients.  It is increasingly rare for the sell side to conduct primary research, and when it does, inputs are limited, undercutting its statistical validity.

At the same time, low cost cloud computing and improved analytic software are making it easier for the buy side to analyze complex data sets.  Models are increasingly sophisticated and supersede the traditional spreadsheet models most analysts use.  The lowered infrastructure costs have made it more feasible for smaller asset managers to compete with the large hedge funds that have invested in custom-built platforms.

The opportunity exists for research providers to raise their game also.  Sell side analysts, as well as buy side analysts, will have to improve their skill sets:

“…to increase their value, analysts will have to do statistical modeling and use analytics tools to gain a deeper understanding of what drivers move markets, sectors or particular stocks. Data discovery and visualization tools will replace spreadsheets for identifying dependencies, patterns and trends, valuation analysis, and investment decision making. Analysts will also need a deeper understanding of client strategies and trading styles in order to tailor their ‘research’ to individual clients.”


The departure for the Edison/Frost paper is regulatory change which is still uncertain.  It is not clear, to us at least, how far or how fast UK and European regulators will go with their prospective reforms.  Nor is it certain that changes in the UK will necessarily be transmitted to other domiciles.  While it is true that commission sharing arrangements (CSAs) spread to the US from the UK with minimal support from US regulators, we strongly doubt that asset managers will forgo the ability to pay for research with client commissions absent decisive regulatory action.  And we see no evidence of US regulators taking up the UK cudgel.

Nevertheless, we believe that many of the changes foreseen by the Edison/Frost paper will happen as a result of market pressures, as commissions continue to be under pressure.  Regulatory reforms would accelerate a process already largely in place.  While unbundling of bank research is unlikely without regulatory intervention (and may not even occur with it), continued consolidation and rationalization is a virtual certainty if current commission trends continue.  Independent research and other diverse sources of research would be long-term beneficiaries of increased market rationalization, but they are not immune from the short-term pressures.

TABB is also accurate in its prediction that big data analytics will have a big impact on research.  We were talking last week with a mid-sized hedge fund that is hiring programmers to implement in-house analytics for big data.  The frustration is that many of the data sources have limited history and do not correlate well with market metrics.  This will improve over time, and we will continue to see innovative research providers capitalizing on this trend.

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Sell-Side Analysts Less Accurate in Bear Markets

January 20th, 2014

There have been numerous studies which question the accuracy of sell-side research due to the optimistic bias associated with trying to win investment banking business.  However, some think this impact should disappear in bear markets, enabling sell-side research to be more accurate during these periods.  However, a recent academic study shows that sell-side research recommendations may be worse in bear markets than in bull markets.

New Study on Sell-Side Research Accuracy

There is a great deal of literature on the accuracy of sell-side research.  However, most studies ignore whether the state of the economy affects analyst performance.  Clearly, in recessions and crises there is greater uncertainty surrounding the prospects for public companies and there is greater volatility in their results.  Consequently, analysts’ ability to make sense of this uncertainty makes them even more important in bad times than in good times.

During the fourth quarter of 2013, Roger Loh of Singapore Management University and René Stulz of Ohio State University published an academic study called “Is sell-side research more valuable in bad times?” which evaluates sell-side analysts’ earnings forecasts, and the BUY or SELL recommendations they issued for the period 1983-2011.

Loh and Stulz found that sell-side analysts’ earnings forecast accuracy was worse in bad times than in good times and that they disagree more.  For example, analysts’ forecasts of a company’s profits for the next quarter were 46% less accurate during periods of financial crisis than at other times.

Potential Reasons for the Drop in Accuracy

Some might argue the reason that sell-side analysts are less accurate during bad times is because they are distracted by economic concerns which might lead them to seek new employment, thereby becoming less productive.  However, Loh and Stulz found that sell-side analysts actually produce more earnings and recommendation revisions during bad times than they do during good times, one measure that sell-side analysts actually work harder during bad times than good times.

Others suggest that the drop in analyst accuracy might be linked to cuts in research budgets. During downturns investment banks spend less on research, cutting staff and reducing compensation. For instance, in the most recent crisis sell-side research budgets were cut by around 40%, as firms replaced many experienced (and more expensive) analysts with younger, less expensive ones.

Analysts Opinions More Valuable in Bear Markets

Despite more inaccurate earnings forecasts, Loh and Stulz found that analyst revisions to earnings forecasts and stock recommendations have a more significant impact on stock-price movement during bad times than during other times.

The recent study found that during normal times only one in ten analyst recommendation changes results in moving the price of the share in question.  However, in falling markets this proportion increases to one in seven analyst recommendation changes moving the relevant stock price.  This is due to the increased uncertainty that exists during bad times and falling markets.


The study by Loh and Stulz finds that the accuracy of sell-side analysts’ earnings estimates and BUY SELL recommendations drops during difficult economic and bearish stock market conditions when compared to good times.  However, they also found that the uncertainty surrounding these difficult times prompts investors to place more importance on sell-side analysts’ forecasts in bad times.


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Update on Proposed Ban on Commission Payments for Corporate Access

January 13th, 2014

Here is the latest on proposed regulatory restrictions in the UK on commission payments for corporate access and a potential ban on payment for research with client commissions generally.  The good news is that there seems slightly less concern that regulators will prohibit research commissions altogether, but the current read is that regulators are unlikely to soften the proposed limits on commission payments for corporate access.

Corporate access and primary research

From what we have heard, UK asset managers are resigned to a ban on payments for corporate access with client commissions.  Although briefing notes or a research analyst’s input before a corporate access meeting would be eligible for payment with client commissions, payment would be limited to that component only, not the entirety of the arranging service.  Thus the bulk of corporate access payments would need to be paid for out of the asset manager’s pocket or clients would have to be explicitly billed for corporate access costs as add-on fees.

As we noted earlier, primary research and market data would also potentially be impacted.  Expert consultations, channel checks, surveys and other forms of primary research often do not include analysis and insight as part of the service.  As with corporate access, any component providing insight would need to be unbundled and paid for separately.  Similarly, market data services would also have to bill separately for its ‘substantive’ research components with the bulk of market data feeds paid by asset managers with their own monies.

How big a change?

Some commentators believe that the definition of research proposed in CP 13/17 is a significant change from the rules implemented in 2006.  It is true that the FCA is proposing the concept of “substantive research”.  However, the four components which define research eligible for payment with commissions are largely unchanged from 2006.  As before, to be payable with client commissions research in the UK must provide: 1) new insights, 2) original thought, 3) intellectual rigor, and 4) meaningful conclusions involving analysis and manipulation of data.   It is unclear how corporate access, consultations or raw surveys have ever met those definitions.  “Substantive research” seems merely a label the FCA is using to underscore its research definitions, which are the same as in 2006.

Also unchanged from 2006 is the explicit intent that client commissions should not be paid for internally generated research.  From the original rule: “It [commission payment for execution or research] has no application in relation to research generated internally by an investment manager itself.”  This further complicates the argument for payment of primary research with client commissions.

Overall, our sense is that industry generally accepts the FCA’s view that CP 13/17 is a clarification of existing rules rather than substantive new rules.  The industry expects that more rules are to come, and that is the real concern.


The Investment Management Association and its blue ribbon panel are working to complete a review of the research market by the end of January.  It is expected that the IMA paper will outline industry best practices with the goal of convincing regulators to maintain the current commission regime pending industry improvements.  It is likely the IMA will recommend improved procurement policies with more explicit budgeting for external research and better voting/valuation measures.  The industry seeks to break the pattern of automatically paying more for research when trading volumes increase, and expects that the total commissions spent on research will decline in the future from more rigorous procurement discipline.  The IMA will probably call upon investment banks to provide more transparency on pricing of its different service levels rather than explicit pricing of all research components.

As we noted previously, the IMA leadership seems willing to throw corporate access under the bus in order to maintain credibility for the current commission regime.  The FCA has explicitly welcomed the IMA review and has signaled that the IMA will have an impact on whether it decides to move forward with a complete ban on commission payments for research.

The Europeans

The FCA noted in its consultation paper that negotiations to revise MiFID were underway, and there was speculation that the MiFID II discussions were providing some of the urgency behind the FCA’s actions.

The relevant part of MiFID II is a potential ban on inducements paid or received by investment advisors.  The provision was partly intended to develop consistent rules governing rebates to independent advisers distributing asset management products, but could have a much broader reach.  Rebates to financial advisers were banned in the UK a year ago, but for the rest of Europe there are conflicting practices and regulations.

Current MiFID regulation has rules governing commission payments to third parties, but the draft directive bans third party inducements altogether, potentially impacting commission payments for research as well as the intended restriction on rebates to financial advisers.  See this Linklaters’ publication for a summary of existing and proposed inducements regulation.

MiFID II is the subject of trialogue discussions between the European parliament, European Commission and European Council.  The commission favors a full ban on inducements, while the council and parliament would like the ban to apply only to independent advisers.  Apparently, there was language proposed that would explicitly exempt payments for research, but this language was rejected.

Because no agreement was reached by the end of 2013, the topic will be delayed until the next European parliamentary elections in May, 2014.  The FCA now has more breathing room to formulate its own policies.

The investment banks

The investment banks, who were feeling like wallflowers in this debate just a few months ago, now have the FCA crawling through their undergarments as part of its thematic review.  The FCA is scrutinizing sell-side practices as part of its examination of bundled brokerage arrangements.  What the FCA finds could have a big influence on how the regulation ultimately plays out.  If the FCA finds evidence that commission payments influence IPO allocations, likely followed by the usual media hysterics, all the IMA’s hard work to contain the issue may be for naught.

The investment banks are understandably reluctant to provide more transparency in the pricing of their research services.  The current process allows banks to maximize revenues by telling each asset manager it is underpaying for the research it consumes.  Nevertheless, investment banks, now faced with declining commissions from a proposed ban on payments for corporate access, have a legitimate concern about how deep a hit they will be taking to their already fragile equity businesses.  They will argue to the FCA that if it pushes too hard, equities markets will suffer from more banks downsizing their equities businesses.

The independents

EuroIRP, which likely started this whole mess with its 2011 report challenging whether corporate access met the UK definition of research, is now in a quandary.  Having sicked the regulatory dogs on corporate access it now finds the topic has grown to very uncomfortable proportions.  EuroIRP’s U.S. counterpart, Investorside, is planning to also weigh in and has similar qualms.

By our estimates, independent research in aggregate lost market share to investment banks during the post-crisis decline in commissions.  It is therefore understandable that independents quail at the prospect of further commission declines.

In principle, an outright ban on commission payments for research would provide a much more level playing field for independents than currently exists with bundled investment bank research.  However, independents have recently seen investment banks favored during a declining commission environment, and worry that investment banks have a greater ability to cross-subsidize their research.

The good news is that the independents have a seat at the table.  The FCA seems sympathetic to independent research, recognizing that independents already provide more transparency than bank research.  The FCA has stated as one of its goals the creation of a more competitive research marketplace, and wiping out independent research is not a good step in that direction.


As we have noted previously, the head of the FCA is highly engaged, believing that significant reform to the current regime is necessary.  Those who have interacted with FCA staff sense that intellectually they favor a ban on research commissions but would be happy if the result is achieved organically rather than through regulation.

The FCA’s leadership position relative to its European counterparts has been undermined by the UK’s greater distancing from the EU over the last few years.  In some ways, a ban resulting from MiFID’s inducement language would take the onus off the FCA, allowing it to put the blame on its European counterparts.  However, the FCA shows every sign of wanting to drive the bus on this issue rather than having the issue become European roadkill.


Investment banks, investment managers and other power brokers hoping to influence the FCA on the topic would likely go through the Treasury Select Committee, which is a committee appointed by the House of Commons to review the FCA, along with HM Treasury, the Bank of England and other finance-related public bodies.  Committee members might be sympathetic to arguments that banning commission payments for research would create an unlevel playing ground for UK asset managers and batter UK investment banks.  However, any additional abuses surfacing as a result of the FCA’s thematic review could quickly neutralize such efforts.


Some U.S.-based research providers, including U.S.-based investment banks, have awoken with a start to this issue which has been brewing for well over a year.  The Americans are ready to apply their ‘can do’ spirit to trying to prevent a UK ban on corporate access.  Our sense is that the UK institutions have largely accepted CP 13/17 as a fait accompli and are more focused on containing regulatory zeal for further reforms to the commission regime.

At the same time, UK sources sound a bit more sanguine that the FCA will give the industry time to implement best practices before pressing on with further reforms, and that European intransigence will allow the UK maintain some level of leadership on the issue.  However, the wild card is the FCA thematic review which could fold the IMA’s hand.

Next out of the box will be IMA’s report, expected around the end of this month.  The comment period for CP 13/17 ends February 25, 2014.   The FCA intends to implement CP 13/17 later in the spring of 2014 and expects to release the results of its thematic review after the implementation of the changes proposed in CP 13/17.  Stay tuned.

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CFRA and Management CV Announce Strategic Alliance

January 9th, 2014

Earlier this week, well-known independent forensic accounting research firm, CFRA, announced that it had formed a strategic alliance with Management CV, a research firm focused on conducting due diligence and rating the quality of public company management teams.

The alliance will result in a cross promotion of the two firms’ institutional research products to the other firm’s customers.  In addition, the two firms will investigate how to potentially integrate their products more closely to meet investors’ needs in the future.

For more details about this arrangement, refer to the press release posted below.


New York, NY – January 7, 2014 – CFRA, the global leader in forensic accounting research, analytics and advisory services, and Management CV, an investment research firm that specializes in the due diligence of company management teams, announced today a strategic alliance to promote and integrate each other’s products and services.

Under the terms of the agreement, CFRA and Management CV will work with their respective institutional clients to better identify problematic financial accounting and underperforming management teams prior to negative market reactions to those issues.  The two firms already share a strong following among elite institutional investors, insurance firms, commercial lenders, and other risk management professionals.

The alliance will provide global investors, risk managers and lenders with a unique and actionable suite of diligence and data to better identify opportunities and avoid risks in the equity and credit markets.  Initially, CFRA will promote Management CV’s proven methodology for analyzing the skill and quality of CEOs and CFOs, while Management CV will promote CFRA’s expertise in identifying questionable accounting practices.  The parties will also conduct a joint study on the correlation between relative earnings quality and the quality of management teams.

“Sophisticated investors, risk managers and lenders understand that widely reported financial results do not always reflect the true underlying economic reality of a company.  Over our 20+ year track record, CFRA has consistently proven this reality through our unbiased forensic accounting expertise and analysis. But financial analysis is not the only part of the puzzle, and fiduciaries must be able to quickly and objectively evaluate the skills and motivations of the CEOs and CFOs running these firms,” said Peter E. de Boer, CEO, CFRA. “Through our partnership with Management CV, we will provide a unique level of insight to enhance investment returns and reduce risk.”

“People and financial diligence are two sides of the same coin that no fiduciary can afford to ignore when investing or lending.  CEO and CFO turnover has been running at record levels for public companies in recent years, and portfolio managers rely on us to give them a quick and factual appraisal that often correlates to excess returns,” said Renny Ponvert, founder of Management CV. “Our partnership with CFRA brings together two critical elements of the research mosaic, hard data and insightful analytics to allow investors and risk managers to better identify the bright and dark spots on the horizon.”

About CFRA

CFRA is the global leader in forensic accounting research, analytics and advisory services, serving asset managers, asset owners, insurance companies, and other professional organizations. CFRA’s global team of analysts offers unmatched expertise in uncovering aggressive accounting tactics and instances of accounting fraud across a wide range of industries and geographies, including North America, Europe and Asia. With over 20+ years of operating history, CFRA’s proven research and analytical processes consistently identify situations where reported financial results do not provide the true picture of a company’s health, thereby helping our clients to enhance investment returns and reduce portfolio risk. For more information, please visit

About Management CV

Management CV provides institutional investors with a structured methodology for analyzing the skill and quality of CEOs and their management teams.  Our Management Team Quality ranks have been shown to be statistically significant in forecasting company operating results.  Investors and risk managers can use our ranking system and concise one page analyst reports to dramatically improve relative returns and reduce portfolio risk.  For more information, please visit

Media contacts:

Gitenstein & Assadi PR
Susan Assadi,
Jake Nesbitt,
800 922 8792 or 480 860 8792


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Outlook for 2014

January 6th, 2014

It is time for us to squint into the crystal ball for 2014…

Equity commissions

By rights, 2013 should have been a boom year for equity commissions.  The S&P 500 increased 32% for the year, and trading volumes should have surged also, yet we estimate that trading volumes for US equities were down 5.5% in 2013.  What will it take for trading volumes to increase?

Although 2013 was frustrating for what it might/could/should have been, most research providers seemed content that commissions were no longer plummeting.  Anecdotal evidence from the research providers we speak with suggests that the market environment in 2013 was an improvement over 2012, and for that researchers were grateful.

Will the trend of declining commissions reverse in 2014?  After 5 years of declining commissions, surely commissions must bottom.  However, it is hard to see what will trigger a revival.  If trading volumes can’t be lifted by a 30%+ market, they are unlikely to respond to a more subdued 2014 market predicted by strategists.  And, while commission rates have been relatively stable, the prospect of rising commission rates is remote.  Nevertheless, for many research providers a ‘meh’ environment is still an improvement over the post-crisis turmoil.

M&A and Consolidation

Acquisitions were relatively robust in 2013, but it remains a buyer’s market with valuations below pre-crisis levels.  We are likely to see more activity in 2014, particularly earnouts and partnerships such as Ford Equity Research’s merger with Columbine Capital Services and Cowen Group’s acquisition of Dahlman Rose & Co.  It is also safe to say that the ongoing pressures of the research environment will lead to further research exits.

Investment banks

Investment banks have been quietly rationalizing their research departments.  Last year’s Institutional Investor poll suggested that Barclays and Credit Suisse weakened their commitment to research while Deutsche Bank and Goldman Sachs were content to tread water.  Jefferies, previously a bulge wannabe, shifted its energies to building partnerships with regional Asian brokerages.

Although investment banks may have costs more aligned to current market conditions, the more troubling question is the upside for their equities departments.  Investment banks can withstand famines so long as there are feast years.  But what if there are no more feast years for equities?  This logic may lead to additional bulge bracket exits from equities in 2014, following RBS’s lead.  More likely, bulge firms will continue to squeeze their research, hoping that conditions miraculously improve.

Regionals and independents

For regional banks, IPO volumes are a more important bellwether for their research than equity commission volumes since they support themselves on small cap equity issuance.  Unlike equity commissions, IPO volume followed the exuberant equity market, up 29% during 2013.

Independent research providers are less dependent on commissions, relying more on subscriptions and having a smaller share of the research pie overall.  2013 seemed a more positive year for independent research as investors again began to seek out differentiated non-consensus research.  Post-crisis, as commissions were in free-fall, an increasing share of commission allocations went to the largest investment banks.  Now, in a less-stressed commission environment, it appears that independents are winning some of that share back.

Fundamental research

A major positive for most research providers–and fundamental providers in particular–has been a shift away from lockstep macro markets.  Average correlations of 30% are more conducive to stock picking than the 50-60% correlations experienced post-crisis.

Sector specialists also benefited from last year’s broad market increase where all industry sectors showed gains.  The market in 2014 is likely to be more selective in favoring industry sectors, providing challenges for boutiques specializing in out-of-favor sectors.

Other research types

Investment research is highly diversified and the rising market in 2013 did not float all research boats.  The improved stock picking market was not a positive for economic research providers, yet macro uncertainties remain for 2014.  Economic providers no longer have a gale-force wind at their back, but neither do they face strong headwinds.

For forensic research providers and other short-oriented providers, 2013 was a more challenging year.  2014 offers more promise with increased concern over market levels and valuations.

Political intelligence firms received much scrutiny in 2013 but no regulatory initiatives.  It is possible we will see an enforcement action involving political intelligence, but we think the chances are diminished.  Mid-term elections will be a slight negative, dampening new policy initiatives.  However, underlying demand for insights from Washington will continue.

ESG providers are still waiting for U.S. asset owners to evidence the ESG concerns of their European counterparts.  We think ESG is a sleeper category which will find its time in the sun, but it is uncertain whether 2014 will deliver the wake-up call.

Primary research

Expert networks have rebounded from the panic generated by the insider trading investigations in 2010.  The industry is now more concentrated with fewer smaller players, and more diversified geographically and outside the financial sector.  Channel checkers and market research firms have also seen improvements from normalizing markets.

The UK regulatory crackdown on payment for corporate access with client commissions will be problematic for primary research providers with UK operations.  The UK definition of research eligible for commission payments makes it difficult to pay for primary research with client commissions also.  The bigger concern is whether the UK stance on corporate access will be exported to other domiciles.


We will be watching UK regulatory developments carefully in the coming year.  We suspect a ban on commission payments for corporate access is a foregone conclusion, even though the regulation is subject to industry comment.  A ban would hurt investment banks most: historically 30% of commission allocations have been for corporate access according to the Extel survey.

UK regulatory actions may not stop at corporate access, however.  The Financial Conduct Authority (FCA) has questioned whether client commissions should be paid for any research, full stop.  At the same time, language in the upcoming MiFID II regulation may similarly impact commission payments for research.  Even if regulators pull back from an outright ban, the research market in the UK will be seriously impacted.  And these impacts can be felt in other markets if larger investment managers implement revised policies globally.

Insider Trading

2014 will bring the trial of Mathew Martoma which starts tomorrow.  Assuming Martoma and/or Steinberg do not ‘flip’, the main insider trading show will then be over.  There will be a variety of clean-up convictions for smaller fry caught in the quest to nail Steve Cohen, but the forces behind the main investigation will have dissipated.

The SEC’s Mary Jo White says insider trading remains an important enforcement priority, while at the same time trying to set new priorities, such as accounting fraud.  The SEC is averaging 50 insider trading actions a year, and this is likely to continue.  While insider trading won’t be as headline grabbing, it will remain a compliance priority for investors.

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Instinet Fined for Improper Commission Payments

January 2nd, 2014

The U.S. Securities and Exchange Commission (SEC) on December 26 sanctioned New York-based Instinet LLC for improperly making soft dollar commission payments in a negotiated settlement costing Instinet $813,000.

Last August, as we reported at the time, the SEC nailed a San Diego-based investment adviser, J.S. Oliver Capital Management, for misappropriating over $1million in soft dollar commissions, including divorce payments to the principal’s wife, illegal payments to the principal and for the principal’s apartment in New York City.  The SEC claimed that there were ample signs for Instinet to realize that such payments were improper.  As part of its settlement, Instinet neither admitted nor denied the SEC’s findings.

According to the SEC’s administrative order, Instinet ignored red flags while approving soft dollar payments to J.S. Oliver from January 2009 to July 2010:

  • J.S. Oliver provided Instinet with inconsistent reasons for a payment of more than $329,000 to the principal’s ex-wife under the guise of employee compensation.  The payment was actually related to the principal’s divorce.  Instinet approved the payment despite a purported employment agreement provided by J.S. Oliver that, while significantly altered, still failed to indicate that the ex-wife had performed any work for J.S. Oliver after 2006.
  • After J.S. Oliver had submitted invoices to Instinet indicating a monthly rent of $10,000 for all of 2009, the firm requested soft dollars in July 2009 for a 50 percent increase in rent to $15,000 per month.  However, J.S. Oliver rented offices in the principal’s home, and Instinet knew that the principal owned the company to which the rent was paid.  The increased rent payments were inflated for the principal’s personal benefit and not properly disclosed to J.S. Oliver clients.  Nevertheless, Instinet approved $65,000 in soft dollar payments for the rent increase over a period of 13 months.
  • J.S. Oliver again provided Instinet with inconsistent reasons for two requested soft dollar payments purportedly for the principal’s travel expenses related to evaluating “potential investment opportunities.”  However, the expenses actually were for maintenance, taxes, and fees on the principal’s personal timeshare in New York City.  Despite copies of timeshare bills that were clearly in the principal’s name indicating the payments would be for his own financial benefit, Instinet approved the soft dollar payments totaling more than $40,000.

According to the SEC, Instinet “willfully aided and abetted and caused JS Oliver’s violations of Sections 206(2) of the Advisers Act, which prohibits an investment adviser from engaging in any transaction, practice, or course of business which operates as a fraud or deceit upon a client or prospective client, and Section 206(4) of the Advisers Act and Rule 206(4) 8 thereunder, which prohibit fraudulent conduct by an investment adviser to pooled investment vehicles.”

Instinet agreed to pay a penalty of $375,000, disgorgement of $378,673.76, and prejudgment interest of $59,607.66.  Instinet must hire an independent compliance consultant to review its policies, procedures, and practices related to soft dollar payments.  The firm also consented to a censure and a cease-and-desist order.

Instinet’s disgorgement of $378,673.76 presumably relates to the commissions accruing to Instinet during the improper trades.  Instinet generally agreed to give JS Oliver a soft dollar credit of $0.0225 for every $0.03 of brokerage commissions generated per share by JS Oliver clients’ equity trades, according to the SEC.

Conclusion:  Although payment for employee compensation and rent is not typically permissible under Section 28(e) of the Securities Exchange Act of 1934, it is allowed if disclosed to investors in the offering documents.  Effectively, the SEC is telling commission brokers that they must monitor the payment terms for each commission client and ensure that payments are consistent with those provisions.  In the case of J.S. Oliver, the SEC found the violations egregious enough to throw the book at Instinet as well as the asset manager.

The more interesting question is whether this example of soft dollar abuse will incline the SEC to cooperate with their regulatory colleagues across the pond who are contemplating radical changes to the commission regime.

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