Tale of Two Regulators


New York—Over the past week we’ve had the opportunity to hear regulatory staff from the U.S. Securities and Exchange Commission and the UK Financial Services Authority speak on their respective regulations of commissions used to pay for research.  Distinctions between the two raise questions about the different regulatory approaches—and which are ultimately more effective.

Last Wednesday, Mike Mayhew and I were speaking at the AQ Research conference in London, which also featured a panel with Christopher Preston from the FSA’s Institutional Business Policy group.   The FSA was originally spurred to action on commissions by the Myners Report in 2001 which among other things highlighted the lack of transparency of commission payments.  After a consultation period, the FSA drafted regulation in 2004 which was implemented in 2006.  The new regulation: 1) narrowed what was permissible to be paid for by commissions; 2) implemented increased disclosure of commissions used for execution and research and 3) kick started pricing mechanisms for research, requiring ex-ante splits of commissions into execution components and research components.  The FSA also created an environment conducive to the spread of Commission Sharing Arrangements.

The FSA is now reviewing the results.  Beginning last year, it has met with 15 or 16 money managers to assess what has changed and what else needs to be done.  It has retained consultants to assess the impact of the regulation.   Preston indicated that the FSA was ‘broadly encouraged’ and the response from the market has been ‘reasonably positive.’   The ex-ante pricing discussions have been constructive, broker voting is widely adopted, brokers report that feedback received has been useful in prioritizing resources, and there has been a downward drift in commission rates.   One area of disappointment for the FSA has been that trustees have not provided much feedback on fees, despite the increased disclosure.  “Not entirely unexpected, but there is a need to address,” Preston said.  The FSA is considering whether pension consultants might be a point of leverage in putting pressure on trustees.

Then we heard from Patrick Joyce, Special Counsel from the SEC’s Division of Market Regulation at Monday’s Investorside conference.  Actually, before we heard from Joyce the panel’s first priority was regulation not associated with the SEC—the Department of Labor’s revisions to Form 5500 [click here to see previous commentary], the annual filing made by pension funds, which is now requiring disclosure of research received through indirect compensation (commissions).  Then discussion turned to the SEC’s proposed revisions to Form ADV, which is filed by investment advisors.  Actually, there wasn’t much discussion since the changes to Form ADV, as they pertain to commission disclosure, are minor.  There was mention that the SEC is working on guidance for fund directors regarding commission disclosure, but Joyce could not comment on when—or if—this regulation would be completed since it is being drafted by a different division, the Division of Investment Management.

The two regulators are at very different places regarding commission regulation.  The FSA is busy working on second generation modifications to its disclosure regime, while the SEC is struggling to produce first generation regulation on commission disclosure, despite repeatedly announced promises from its chairman and division directors.   Why the stark contrast?  One answer lies in the way the regulators are organized.  The FSA was created in 1998 through a merger of 4 or 5 separate regulators giving it a consolidated, unified mandate.  No such consolidation has occurred in the U.S., as highlighted by the Treasury’s recent proposal to consolidate financial regulators.

However, in the case of commission regulation, the SEC has the requisite authority, but has been unable to exercise it.  One problem is that the different divisions operate in a highly independent fashion.  The division most familiar with Rule 28(e) is the Division of Market Regulation which regulates investment banks whereas the disclosure regulation has been the responsibility for commission disclosure lies in the Division of Investment Management, which regulates investment advisors.  It is apparent there is little collaboration between the two areas.

The other problem appears to be one of management.  Despite high drama from the current SEC Chairman, Christopher Cox, who at one point called for the abolition of commission payments for research, there is no effective management structure.  Political appointees at the commissioner level and director level have modest sway over staffers, who can act—or not act—with impunity.

The SEC glosses over its inaction by claiming to seek a market led solution.  In fairness, it has clarified some of the issues surrounding the use of Commission Sharing Agreements (called Client Commission Arrangements in the US), although open issues remain.  Nevertheless, CSAs alone will not improve commission disclosure.  Lacking a regulatory framework for commission disclosure, CSA adoption in the U.S. is around 20-30% versus 60-70% in the UK.  Further, CSAs would not have gained popularity if the FSA hadn’t taken the initiative.  On commission disclosure, the SEC appears content to ride the coat-tails of other regulators.


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