New York, NY – The January 8, 2007 edition of Pensions & Investments Magazine has an article written by Beatrix Payne titled, “U.K. Trading Commissions Rise as Banks Quit Programs“.
The article attempts to answer why many institutional investment plan’s commission recapture programs are being discontinued. The article also attempts to identify why commission recapture programs are being discontinued at a higher rate in the U.K than in the U.S. The article mentions that brokerage commission rates appear to have risen somewhat in the U.K in the wake of the Financial Services Authority‘s regulations on the appropriate use of soft commissions. Ms. Payne questioned several investment professionals and their thoughts and opinions are included in the article.
There is one explanation, for the set of observed phenomena that none of the investment professionals mention. I believe this one explanation may provide further insight and help explain the changes in commission recapture programs. The explanation is:
(1) Most “commission recapture programs” are designed with the intention of preventing institutional investment advisors from using brokerage commissions for purposes other than to compensate brokers for execution related costs, research acquisition and other uses that fall under advisors’ “fiduciary investment discretion” and which exclusively benefit the institutional investment plan, or account owner.
(2) Recent regulations by the Financial Services Authority and the SEC’s Interpretive Guidance relating to the appropriate use of institutional client’s brokerage commissions, give “plan sponsors”, investment plan trustees, and mutual fund directors some confidence that they can control their investment advisor’s use of commission premiums (paid above the cost of execution and research acquisition) without the necessity of commission recapture programs.
(3) Why commission recapture programs currently have a higher rate of abandonment in the U.K. than in the U.S., might be explained by contrasts in the two regulatory environments.
(a). In the U.K. the Financial Services Authority (FSA) suggested that institutional investment advisors adopt disclosure regimen at least as revealing as those outlined in U.K. Investment Management Association‘s “Pension Fund Disclosure Code” ( see link )
(b). In the SEC’s recently released “Commission Guidance Regarding Client Commission Practices Under Section 28(e) of the Securities Exchange Act of 1934” (published July 24, 2006 ) and this “Commission Guidance” does not include any suggested or mandated requirement for identification, disclosure, or the accounting of brokerage commissions used to purchase proprietary “services”. Therefore it shouldn’t be surprising that investment plan trustees, and mutual fund directors are reluctant to relinquish the element of control commission recapture programs have provided for controlling the use of client brokerage commissions, by their hired fiduciary investment advisors. Institutional investment plan trustees are co-fiduciaries with the investment advisors they employ, both co-fiduciaries have the obligation to protect account owner’s commissions. To a large degree commission recapture programs have been implemented to control excesses in the use of institutional client commission dollars.
(4) I believe that the increase in commission rates in the U.K may be temporary. It seems reasonable to suggest that U.K. brokerage commissions rates have risen because brokers can charge higher rates only until trends are established under the new guidelines. Once and (for the U.S., IF) execution cost analysis and the costs of proprietary research, and third party research costs and expenses clearly reveal the cost of the appropriate use of institutional client’s brokerage commissions, competition will drive those commissions down, and commission recapture programs will be an historic footnote. So, U. K. commission rates should fall once disclosures allow analysis of the component costs of brokerage commissions.
Recent events in the evolution of Commission Sharing Arrangements (particularly the SEC’s GS&Co. Research Express “No Action Letter”) do nothing to improve disclosure or to provide comfort that institutional clients’ commissions will be spent appropriately. (In fact, I would say the evolution seems to be moving away from that objective). Therefore, I believe the termination of commission recapture programs in the U.S. will come to an abrupt halt and will perhaps increase as unregistered “research” providers proliferate under Commission Sharing Arrangements.
THE ABOVE POST, WRITTEN BY LOYAL RESEARCHWATCH READER, WILLIAM GEORGE, PROVIDES AN INSIGHTFUL PERSPECTIVE ON WHY COMMISSION RECAPTURE PROGRAMS ARE BEING DISCONTINUED IN THE UK AT A MORE RAPID PACE THAN THEY ARE IN THE US.