More Reasons For Concern Over CSAs


New York, NY – As we discussed this morning, CSAs and CCAs could pose problems for money managers.  One ResearchWatch reader, Mr. William George, posted a comment which provides additional reasons he thinks asset managers might be concerned about the new CSA regime.


First, I want to thank Integrity’s ResearchWatch for referencing my “Request for Rulemaking on Disclosure and Transparency in Client Commission Arrangements” in your article on Sunday March 11, 2007 titled “Where Has Commission Disclosure Gone” (see, ).

Then, let me say that your Sunday March 18, 2007 article “The Dark Side of CSA’s for the Buy-Side” mentions many of the problems with Commission Sharing Arrangements (CSA’s) and Client Commission Arrangements that I see, and it outlines some of the issues that motivated me to file my “Request for Rulemaking” with the SEC.

However, I am commenting here to mention a couple of my other concerns about CSA’s and CCA’s, not mentioned in your article, which I believe will negatively impact buy-side fiduciaries, and which will also negatively impact independent research, third-party and regional brokerage firms, and clients whose investment advisors use institutional full-service brokerage firms.

In general, I believe that without the mandate (and enforcement of the mandate) to unbundle and price proprietary services in institutional brokerage arrangements the new definitions for CSA’s and CCA’s will provide greater opportunities for the kinds of conflicts of interest and fraud that have been the subject of the brokerage and investment advisory scandals and prosecutions for the last seven, or so, years.

Commission Sharing Arrangements

Under the “provided-by” clause in the old definition of Commission Sharing Arrangements, the broker “providing” independent research to an advisor was obligated to pay the producer of the research for the specified research before the research was delivered, and the investment advisor could not be contractually obligated to reimburse the broker for “providing” the research (the ‘obligation’ was a gentleman’s agreement).  This forced a very high level of due-diligence and caution on brokerage firms that wanted to provide execution and independent research to institutional advisors. Such brokerage firms are understandably very cautious and selective about which independent research providers they would prepay.  The new definition of Commission Sharing Arrangements does not address the issue of prepayment to research producers.  Will the new definition of Commission Sharing Arrangements encourage the same level of due-diligence and protection for the use of institutional clients’ brokerage commissions that the old definition encouraged?

Client Commission Arrangements

The new definition of Client Commission Arrangements, particularly those arrangements that will be structured as described in the SEC’s recent No Action Letter,* is even more problematic.  In its revised form this “No Action Letter” specifically emphasizes that the executing broker has no liability to pay for the research institutional advisors request.  Further, this new definition of Client Commission Arrangements mentions that investment advisor ‘directed’ research payments will be paid out of a “pool” of excess commissions generated by the advisor’s trading with the executing broker.  Without a stipulation that the value of the proprietary research provided by the executing broker must be identified and disclosed, how can institutional clients, investment advisors and regulators know that brokerage commission payments are being appropriately allocated between: the costs of execution, the costs of proprietary research qualifying for the safe harbor of Section 28(e) provided by the executing broker, the value of other proprietary services provided by the executing broker, and the commission pool from which independent research producers might be paid?  Without the identification and pricing of proprietary services this new definition of Client Commission Arrangement allows clients’ brokerage commissions to be treated a fungible resource for the executing broker until whatever commission is left-over gets allocated to the “Client Commission Pool”.

More Concerns

I have worked for brokerage firms which, under investment advisor ‘directed’ brokerage arrangements, were part of the “selling group” for initial public offerings and secondary underwritings. Typically, the “selling concession” earned by me and my employer for selling the offering took eight months to a year to be paid by the full-service broker who was the investment banker in the deal.  Reflecting on the time value of money should cause one to wonder if ‘slow payment’ to independent research providers will negatively affect the viability of the independent research business.

Another concern should be that under the old interpretations of client commission arrangements the providing broker was liable for the invoice. Under the new definition the investment advisor directs the executing broker to pay the invoice and the advisor is ultimately liable for the payment for research and is also liable for co-fiduciary clients’ directed payments (commission recapture directed by pension advisors to pay for plan services).

Because third-party brokers typically only offer execution and invoice payment, they have no conflicting goals (they don’t pay themselves for proprietary services) and their activities are transparent and documented by the costs of execution and by the invoices they pay. The new definition of Client Commission Arrangements places the investment advisor in the position of negotiating with the full-service broker on behalf of independent research providers and fiduciary clients’ who require directed brokerage payments to pay for appropriate plan services. Is it reasonable to assume that investment advisors will have the integrity, or the will, to negotiate for the exclusive benefit of their clients when such negotiation might reduce the value of favors the full-service brokerage firm will exchange with the advisor?

Is the Securities and Exchange Commission prepared to immediately reassign its substantial independent research payment audit resources from a third-party brokerage focus to focus on auditing investment advisors’ direction for independent research and directed brokerage payments, and will there be better opportunity to detect fraud under the new regimen.

The concerns mentioned in your article and the additional concerns mentioned in this comment are some of the more important reasons why I filed my Request for Rulemaking on Disclosure and Transparency in Client Commission Arrangements with the Securities and Exchange Commission.

* To see the revised No Action Letter>


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