New York, NY – In recent weeks the markets have discussed the strengths and weaknesses of the SEC’s recent proposal to modify Part 2 of Form ADV, which would require that registered investment advisors explain their business practices in “plain english” versus taking the “check the box” approach that is currently required.
It is clear to the team at Integrity Research Associates that the current Form ADV needed to be overhauled as most investment advisers had grossly under reported their use of soft dollars for years. After all, any money manager that pays more than a pure execution only rate, and also receives sell-side research is actually “paying up” and using soft dollars. However, data from Form ADV shows that only 60% of all money managers report that they use soft dollars.
We also admit that a “plain english” description is more useful than the current information disclosure format. However, we also think that the proposed changes to Form ADV really miss the point as they don’t provide sufficient transparency into one of the most opaque aspects of the investment manager / client relationship — how investment managers spend their client commissions, and the services they receive as a result of these practices.
One of the reasons we feel that the proposed changes are missing the point is because we believe that investors have the right to know what their investment managers are doing with their assets. Interestingly, it seems the SEC agrees that it is important that clients (investors) receive sufficient information about the adviser and their practices to make informed investment decisions. The following paragraph is from Section I of the SEC’s recent Amendments to Form ADV.
“Unlike the laws of many other countries, the U.S. federal securities laws do not prescribe minimum experience or qualification requirements for persons providing investment advice. They do not establish maximum fees that advisers may charge. Nor do they preclude advisers from having substantial conflicts of interest that might adversely affect the objectivity of the advice they provide. Rather, investors have the responsibility, based on disclosure they receive, for selecting their own advisers, negotiating their own fee arrangements, and evaluating their advisers’ conflicts. Therefore, it is critical that clients and prospective clients receive sufficient information about the adviser and its personnel to permit them to make an informed decision about whether to engage an adviser, and having engaged the adviser, how to manage that relationship.”
Consequently, it is strange to us that in its Form ADV proposal the SEC has clearly ignored one of the most obvious ways it could reduce potential conflicts of interest and promote greater transparency — by mandating that investment advisers disclose specifically what client commissions are being spent on.
In the past, when such a proposal was discussed, the brokerage industry argued they could not “unbundle” research from execution due to the lack of good information systems.
However, the FSA and the UK money management industry addressed this issue a few years ago by mandating that money managers provide clients with a good faith estimate of how much of client commissions was spent on execution services and investment research.
Unfortunately, the U.S. brokerage and money management industries have both convinced the SEC that this information was either too difficult to produce, or it would cause too much confusion. They argue that investors really can’t understand the intricacies of soft dollars.
The truth is that neither the brokerage nor the money management industry would benefit from clients knowing this information as it would force the buy-side to actually pay for the various research and advisory services they receive, and it would force the sell-side to justify the amount of commissions they charge clients. An opaque commission environment would enable the current inefficient market to continue.
Ultimately, the interests of retail investors, who would benefit from knowing how their commission assets are being spent, have been overlooked once again. In addition, investors have not been provided enough of the right kind of information to enable them to make a good decision on who does the best job balancing investment returns with the costs associated with generating those returns.
We hope that eventually the SEC will understand that protecting individual investors, and providing them with the information they deserve is much more important than promoting the status quo.