New York, NY – As we embark upon a new year, it is good to contemplate the many developments that the investment research industry experienced in the prior twelve months. 2007 was a particularly eventful year as numerous important stories hit the wire, including governmental and regulatory developments, business closings, mergers and acquisitions, important new industry initiatives, and other market developments. The following is Integrity’s assessment of the 10 top stories that took place in 2007.
1. Goldman Sachs Rolls Out New Alternative Research Initiative
Goldman Sachs’ long awaited venture in the independent research industry was officially made public in a Dow Jones news article published in early February 2007. The new venture, called Hudson Street Services, was established to make minority investments and help market promising and unique research services to their over 600 institutional customers that currently used soft dollars to purchase third party research through Goldman Sachs. Goldman now has made minority investments in 7 alternative research firms, including:
· Wall Street On Demand (a custom developer of financial websites),
· Asset4 (an SRI research provider),
· Connotate (a web scraping tool),
· Investars (a research performance measurement provider),
· iSuppli (a technology supply chain management research provider),
· Medley Global Advisors (an economic policy research firm), and
· Lusight Research (a research and data provider on the global emerging markets).
Goldman has stated that they expect to make similar types of investments in at least a dozen firms in the next few years.
2. Cox’s About Face on Soft Dollars
In May, 2007 the Chairman of the Securities and Exchange Commission, Christopher Cox, revealed that he was seeking an outright ban on “soft dollars”. Chairman Cox asked the House Banking Committee to consider changes to the soft dollar safe harbor rules, since he believed these rules encourage money managers to direct trade flow through specific brokers, based on their research, rather than the quality of their execution. In addition, he indicated that these rules might encourage money managers to overtrade client portfolios in direct conflict with their fiduciary responsibilities to clients.
Cox’s stance was confusing to many as it was contrary to the position he took in 2006 when he supported the SEC’s Interpretive Guidance on the 28(e) soft dollar “safe harbor”. The SEC Chairman finally backed down on this issue as various legislators, including Charles Schumer (D-NY) publically questioned his change of opinion.
3. The Growing Popularity of CSAs and CCAs
During 2007 many journalists (Integrity included) wrote about the growing popularity of Commission Sharing Agreements, Client Commission Arrangements, and the unbundling of equity commissions between execution and research services.
One survey conducted by Traders Magazine in 2007 suggested that client commission arrangements (CCAs) have spread more quickly and broadly in the U.S. than previously indicated. According to the survey conducted in April, 43% of buy side firms who responded to the survey were using CCAs at that time, and another 12% were planning to begin using them sometime later in 2007. Although it was not a statistically rigorous study, the survey does suggest that the penetration of CCAs in the U.S. is higher than previously thought.
Throughout 2007 Integrity wrote over one dozen articles outlining both the benefits and the risks associated with adopting CCAs and CSAs for the sell-side, buy-side, and the alternative research industry.
4. SEC No Action Letters Establish New Guidelines
In January, 2007 the SEC issued a no action letter in response to a question from Goldman Sachs about whether research providers who participated in its Research XPRESS platform needed to be registered as broker dealers to be paid out of a pool of client commissions. The end result will enable US money managers to do exactly what their UK counterparts have been able to do for the past year – and that is to pay for both broker and non-broker research out of a single pool of commissions.
A few months later the SEC recently issued a second no-action letter to Capital Institutional Services (CAPIS) clarifying that their form of Client Commission Arrangement which uses “credits” to pay for research services does not trigger a requirement for non-broker research vendors to register as brokers.
5. Prudential Financial Shutters Equity Research Division
After looking for a suitor for its research group for several months, Prudential Financial, Inc. decided in June 2007 to shutter its equity research group as a result of the high costs of production, falling commission rates, and the impact of CSAs and CCAs on the firm’s overall trading revenue. The closing of Prudential’s equity research business was the first example of a large well-known firm to shut its research business due, in part, to the impact of CSAs and CCAs on the firm’s execution revenue.
6. Expert Networks Investigated by Authorities
In January, 2007 a Wall Street Journal article revealed that the New York Attorney General’s office was investigating whether consultants paid by expert network providers, Gerson Lehrman and Vista Research, may have inappropriately disclosed important information about the companies in which they work. However, a few months later, several market sources explained that the Feds had also jumped on the “expert network” bandwagon. According to sources familiar with the situation, the US Attorney’s office had also initiated an investigation of their own into the way professional money managers have been using research services like Gerson or Vista to obtain access to material nonpublic information.
7. Mergers, Acquisitions, and Investments in the Research Industry
The investment research M&A / investment landscape was quite active in 2007. In addition to the seven (7) minority investments made by Goldman Sachs in alternative research providers (discussed above), a number of other deals were consummated during the year. In January, 2007 Xinhua Financial closed on its deal to acquire Glass Lewis. In July, RiskMetrics acquired forensic research provider, CFRA. In August, publicly traded HIS, Inc. purchased energy research provider John S. Herold. Reuters also purchased research performance measurement provider, Starmine in August. In October, 2007 Xinhua Financial sold Glass Lewis (purchased earlier in 2007) to the Ontario Teacher’s Pension Plan. Finally in December Silver Lake Partners took a minority stake in Gerson Lehrman Group.
8. Sell-Side Firms Look To Restrict Research Distribution
One topic that became popular in 2007 was sell-side research distribution. This issue was brought to the limelight by a letter written in March 2007 to clients by President of Merrill Lynch Global Research, Candace Browning. In this letter, Ms. Browning announced a new digital distribution strategy that 1) terminated research access to non-clients from Merrill’s proprietary site and external vendor platforms; 2) further restricted and delayed media access to selected content; 3) eliminated existing licensing arrangements that erode the value of Merrill’s written product; and 4) established licensing agreements at market prices competitive with services offered by other providers.
9. SEC Examiners Probe Use of Proprietary Soft Dollars
In October, 2007 Integrity reported that mutual funds were squawking about new examinations detail being requested by examiners from the SEC’s New York office, especially information requested relating to the potential misuse of non-public information. Not specifically cited by irate funds, but nevertheless of interest to our readers, the new examination letters requested information on proprietary soft dollar commissions—i.e., bundled commissions used to pay for broker/dealer research.
10. DOL Backs Down on Soft Dollar Disclosure
In December, 2007 the Department of Labor Employee Benefits Security Administration (EBSA), the regulator of ERISA plans, approved final changes to its disclosure requirements of indirect expenses incurred by investment managers on behalf of their pension fund clients. After significant lobbying by both investment managers and the brokerage industry, the EBSA reduced its disclosure requirements for soft dollars, allowing investment managers to use current disclosures such as the Form ADV to report the use of client commissions to pay for third-party and proprietary research.