The following is a guest article from Tom Brakke, former independent consultant for one of the twelve investment banks that was a party to the $1.5 billion Global Research Analyst Settlement.
The lead article in the March 4 edition of FTfm, the fund management section of the Financial Times, began with this sentence: “Investment banks are charging asset managers up to $20,000 an hour to meet the chief executives of their corporate clients — often without the chief executives having any idea that their time is being sold.”
If the CEOs have been unaware of this practice, they didn’t see the natural convergence of two factors. First, “management access” has vaulted to the top of the lists of services that buy-side firms want from sell-side firms. Second, the sell-side has always figured out a way to get paid (and paid well) for the hot product or service of the day. And, let’s just say unforced disclosure is not the firms’ strong suit.
The payments are sometimes “hard,” that is, coming from direct payments to the brokers. At other times they are “soft,” a part of the pool of commission dollars that asset managers pay to execute trades above the normal rate — or just hidden in the overall bundle of services paid for by commissions. (Yes, if you are a client of those asset managers, the assets being spent are yours. They may or may not be spent wisely.)
The immediate reaction (United States version) is, “What about Regulation Fair Disclosure (Reg FD)?” Among other things, its rules were intended to prevent corporate managers from selectively sharing material nonpublic information with certain favored analysts and investors. So, if someone is paying $20,000 an hour for access, they believe that Reg FD won’t be effectively enforced and/or that CEOs leave a trail of analytical breadcrumbs to find a way out of the forest of shared knowledge to that paradise known as alpha.
(As for United Kingdom reaction to the story, how brazen is it that the practice has continued despite regulator warnings, as seen in Integrity Research’s October posting, “UK Challenges Management Access”?)
Having been in many one-on-one or small group meetings with CEOs (although not for a while), I understand the benefit of being able to quiz them. How do they answer questions? What don’t they know? What makes them uncomfortable?
There are concrete answers that matter and numbers galore that are cited. Those schooled in the financial models of the companies might hear a fact that seems foreign and figure out what that means for the analysis. But often the best hints come from the words used, the body language tells, and other touchy-feely things — not exactly the strong suit of most investment analysts.
So, whether I paid a hefty fee to a broker to have access or got it for free, I’d want to have people in the room that looked at the world from different angles, to triangulate and dissect the story. That’s pretty uncommon in my experience, given that most investment professionals are cut from the same cloth, have similar points of view, and aren’t trained in conducting interviews or observing behavior.
On the other side of the table, CEOs should eliminate the middlemen whenever possible (which is most of the time). They should focus on meeting with investors who have the potential to be long-term shareholders, while diversifying their base of relationships in the investment community. It is easy to have brokers make the arrangements, but what value do they add, really? Whether they are being paid directly or just getting points that will turn into commissions down the line, they are monetizing access to managers that companies can provide for free.
The face time between managements and investors offers opportunities and risks for both sides. As for the other guys in the room, who needs them?
Tom Brakke, CFA, helps organizations develop innovative investment processes. This article first appeared as part of an ongoing series of postings about current equity research topics on his blog, the research puzzle.