New York – Last week, an article in the Wall Street Journal reported that Mike Mayo (a well-known analyst of banks and brokerage firms) and five of his colleagues left Prudential Securities to join the securities arm of Deutsche Bank. According to the article, Mr. Mayo and his colleagues left because they felt that their research opinions would get “wider distribution” at Deutsche Bank than Prudential.
While it is common for analysts to move around over the course of their careers, Mr. Mayo’s departure comes at an inopportune time his employer. Prudential is one of the many mid-tier broker-dealers that are currently getting squeezed by Commission Sharing Agreements (CSAs). These agreements, which have been growing in popularity in recent years, allow money managers to allocate soft dollar commissions to third-party research providers (so long as those providers have signed a participation agreement with a CSA broker).
Prior to the advent of CSAs, most brokerage firms were the exclusive providers of their own research. This practice forced clients to execute with multiple brokers, in some instances purely for their research. As a result, these clients may not have received the best trade execution from these “research brokers”. With CSAs growing in popularity, however, money managers have an incentive to trade only with top-tier or specialty boutique brokerage firms that focus on trade execution. In this competitive environment, it will be difficult for mid-tier broker-dealers like Prudential to compete.
Comment by Bill George:
The Emperor’s New Clothes:
I continually see the goal of “best execution” cited as the reason institutional investment advisors might opt-into Commission Sharing Arrangements (CSA’s) or Client Commission Arrangements (CCA’s). The presumption apparently being that brokerage firms which create CSA and CCA programs, and thereby will execute trades and manage the brokerage ‘commission pools’ available for research payments [under Section 28(e)], have some exclusive ability to provide “best execution”. This presumption seems to be based almost entirely on the anecdotal comments of the brokers which are setting-up these brokerage commission ‘concentration’ programs. I believe accepting self-declaration of a claim of “best execution” is a risky approach to broker selection. Furthermore, I believe that even the acceptance of documented studies of execution quality, without an attempted to understand the various methodologies of transaction cost analysis and how these methodologies can produce different results, also introduces significant risk into the selection of executing brokers.
Based on the articles referenced below, it seems that many of the claims of “best execution” might be about as substantial as the emperor’s new clothes.
Survey of Articles on Best Execution:
The article found here describes a lack of consensus, in the professional investment management community, about what best execution is:
The article found here quotes authors of a recent book titled, MiFID: Convergence Towards a Unified European Capital Markets Industry. When the page at the URL opens scroll down to the section of the article that begins with the statement, “Secondly, a very important element of investor’s protection lies in the so called ‘Best Execution’ provision, or Article 21 of the provision. . . .
The letter you will find at this URL was authored by Wayne Wagner, Chairman of Plexus Group and Mark Edwards Director, Manager of Consulting Services Plexus Group. Plexus Group is a leading transaction cost consulting firm. This letter was submitted to the SEC on February 27, 2004 in response to The SEC’s Concept Release: Request For Comments on Measures to Improve Disclosure of Mutual Fund Transaction Costs (File 33-8349). This comment letter deals with the problems of using the available methods of transaction cost analysis as an effective means for providing disclosure, and for qualifying transaction cost management (best execution).
This URL opens to an abstract of an article which was published in The Journal of Finance (February 2001) titled, Institutional Trading and Soft Dollars by Jennifer S. Conrad, Kevin M. Johnson, and Sunil Wahil. This article mentions that available data and study methodology prevented finding evidence that soft dollar brokerage produced inferior transaction costs.