New York-The SEC recently issued a no action letter to Goldman Sachs which will allow research providers who are not broker dealers to participate in Commission Sharing Arrangements (CSAs). This action will increase the popularity of an already red-hot commodity. It also will bring CSAs in the U.S. more in line with the UK, making it easier for asset managers to utilize Commission Sharing Arrangements globally.
What are CSAs?
Commission Sharing Arrangements allow money managers to pay an executing broker for trade execution and have that broker set aside a pool of commissions which the money manager then allocates to selected research providers. In traditional soft dollars, the research provider or market data provider agree with the money manager to charge a defined fee, which is then paid for by the soft dollar broker from trades directed by the money manager.
CSAs allow commissions to be allocated without a specific price being assigned. CSAs fit easily with broker voting processes, where commissions are allocated based on the value assigned by the various users within a money manager. However, CSAs strip out the execution portion of the commission allocation, so in the CSA context the broker vote allocates the portion of commissions set aside for research.
Goldman’s commission management platform is called Research XPRESS. Included in the platform are commission sharing arrangements, as described in Goldman’s letter to the SEC:
“Through the Research XPRESS program, the money manager directs GS&Co. to record client commissions generated from transactions executed through GS&Co. in a separate pool. The money manager periodically directs GS&Co. to pay specified dollar amounts from that pool for Research Services. The money manager is responsible for independently determining the value of the Research Services in accordance with its good faith determination under Section 28(e) of the Exchange Act, although the money manager’s determination may be based on input from the Service Provider that provides the Research Services.”
Not every firm sets up CSAs the same way, but Goldman’s description is generic.
Before CSAs became popular, research providers needed to be broker dealers to participate in the broker vote process. They had to be B/Ds to receive the commissions allocated from their asset manager clients. For those research providers who ponied up the money for the B/D and a trading desk, the arrangement was typically lucrative once they became embedded in the vote process. Since their trading desks were often rudimentary, asset managers would set aside the easier trades for them, leaving the more difficult trades for the bigger, more sophisticated desks.
With the advent of CSAs, it was assumed that only research providers who were B/Ds could participate if the CSA was being allocated through a broker voting process. This was simply an extension of the pre-CSA regime. Some firms were indicating that research firms which were not B/Ds might participate in a CSA, but only if there were a defined price similar to traditional soft dollars.
The SEC’s no action letter
Goldman Sachs requested a no action letter from the SEC to determine whether research providers receiving commissions allocated through its version of CSAs would need to be registered as broker dealers. The SEC says that it is kosher for a non-broker dealer research provider to participate in a CSA, provided they are in no other respect a broker dealer. Further, research providers which are not broker dealers may participate in broker votes through a CSA. The full text of the no action letter can be viewed at here.
While seemingly arcane, the SEC’s action will have important consequences. Doubtless it will further increase the popularity of CSAs, which were already becoming very popular. Asset managers can now include a broader set of service providers in CSAs, increasing their attractiveness.
From a global perspective, Commission Sharing Arrangements in the U.S. are now more similar to those in the U.K., which never had the broker dealer restriction. Potentially, global CSAs can be developed which would pool commissions across markets (there may be more work involved before this comes to fruition.)
This is good news for research boutiques which are not broker dealers, since they now can be paid through the broker vote rather than through traditional soft dollars. Some asset managers refuse to participate in traditional soft dollars (but embrace soft dollars with bulge firms.)
There are fewer incentives for research houses to be broker dealers. There is very little incentive for non-B/Ds to apply, and it makes it easier for those who are B/Ds to consider shedding the expense if and when economics warrant.
It also becomes harder for those research providers who are holdouts against CSAs. Some research firms which are broker dealers have refused to participate in CSAs, for a number of reasons including the potential loss of the execution portion of commission allocations. However, it gets harder to be a holdout when research providers who are not B/Ds can potentially take your place in the CSA allocation.
Which isn’t to say there aren’t legitimate concerns with CSAs. Some asset managers have expressed concern that the bulge firms which are aggressively promoting CSAs will have too much insight into their broker voting process. The bulge firms’ own proprietary research is subject to the voting process, and may benefit from knowing what is being allocated to competing research services. However, CSAs can and are being set up by agency brokers which are not bulge firms. Most agency brokers offer CSAs of one form or another.
Like it or not, CSAs will be a major factor in transforming the commission world and the recent SEC no action letter will accelerate the process.
Comment by Bill George:
The value of friends in high places . . . PRICELESS.
Any of you common folk who have tried to deal with any of the bureaucracies in Washington D.C. will be startled by this one.
Through its lawyers Goldman Sachs recently requested an opinon or “No Action Letter” on a fairly sophisticated regulatory issue from the SEC. The request was delivered to the SEC “by hand” and is dated January 17, 2007. The requested “No Action Letter” is also dated January 17, 2007. The whole process took less than 24 hours.
In the opinion of many industry professionals the “No Action Letter” will have significant economic impact and will cause significant structural changes in the brokerage industry and third party (independent) research provision.
Thank you Henry, thank you Jon.