Month: October 2013

Best Execution Failure

Exécution_de_Marie_Antoinette_le_16_octobre_1793

Best execution refers to the obligation of an investment adviser to ensure that the prices its orders receive reflect the optimal mix of price improvement, speed and likelihood of execution. The concern is whether the investment adviser is getting some other compensation that influences the decision to use one broker over another. This concern should be heightened when there is an affiliate involved.

In meeting the “best execution” obligation, an adviser must execute securities transactions for clients in such a manner that the clients’ total cost or proceeds in each transaction is the most favorable under the circumstances. In assessing whether this standard is met, an adviser should consider the full range and quality of a broker’s services when placing brokerage, including, among other things, execution capability, commission rate, financial responsibility, responsiveness to the adviser, and the value of any research services provided. That’s a fairly fuzzy standard.

One of the landmark decisions in this area was an administrative proceeding against Mark Bailey & Co.(.pdf). Many of the clients were referred by a third party brokerage firm. The clients would tell the firm to keep using the referral brokerage firm for their transactions. The claim was that the firm violated Section 206(2) of the Advisers Act because the firm failed to negotiate lower brokerage commissions. The SEC also took the position that the firm should have been batching transactions to lower brokerage costs and receive a volume discount. The conflict came from perception that the firm was willing to pay the higher commission to the broker in exchange for continuing referrals from the broker.

A recent case highlighted the conflict when an investment adviser is also affiliated with a fund platform. The SEC brought a case against Manarin Investment Counsel Ltd. and Roland R. Manarin claiming they violated their obligation for “best execution” by selecting higher cost mutual fund shares for the three fund clients even though cheaper shares in the same funds were available. The three funds were advised by Manarin and an affiliate of Manarin served as the broker for investments by the funds.

The SEC claims that Manarin consistently purchased Class A shares with higher fees paid to the affiliated broker instead of institutional shares that would have a lower fee structure.  In effect, this case highlights the need to look at the various classes of mutual fund shares available as part of best execution, not merely the brokerage cost involved. In this case, the conflict was heightened because the higher fees were going to an affiliate of the adviser.

Sources:

Image is Marie Antoinette’s execution in 1793 at the Place de la Révolution

Out of the Office: Bermuda Edition

map of bermuda and compliance

Compliance Building is on assignment to Bermuda this week. Downtown Hamilton is full of post office box company headquarters, rental corporate directors, and offshore transactions. However, I’m heading out into the middle of the Atlantic Ocean for rest and relaxation, not compliance research.

A new post will appear after I finish dusting the pink sand off.

Asset Management and Financial Stability

Asset management report cover

The US Office of Financial Research recently released a report raising concerns that the largest asset managers could pose a threat to financial stability. That puts firms like BlackRock, Deutsche Asset & Wealth Management, Prudential Financial, AXA Investment Managers, MetLife, Invesco and UBS Global Asset Management in the cross-hairs of being considered “systemically important.”

The Financial Stability Oversight Council decided to study the activities of asset management firms to better inform its analysis of whether to consider such firms for enhanced prudential standards and supervision under Section 113 of the Dodd-Frank Act. Section 113 gives the FSOC the power to designate a non-bank firm as a “systemically important financial institution”. Being considered “systemically important” means heightened supervision by the US Federal Reserve and also makes the firm subject to risk-based capital requirements and leverage rules.

The FSOC asked the Office of Financial Research to step in and collect data. The Dodd-Frank Wall Street Reform and Consumer Protection Act established the Office of Financial Research within the Treasury Department to improve the quality of financial data available to policymakers and to facilitate more robust and sophisticated analysis of the financial system.

This report is the first step to seeing greater regulatory control of large asset managers. According to the Report, the U.S. asset management industry oversees the allocation of approximately $53 trillion in financial assets.

The Report asserts that separate accounts managed by large asset managers are less transparent than those of mutual funds, banks, and private funds because the activities are not publicly reported.

The Report identifies four key factors that make the industry vulnerable to shocks:

(1) “reaching for yield” and herding behaviors;
(2) redemption risk in collective investment vehicles;
(3) leverage, which can amplify asset price movements and increase the potential for fire sales; and
(4) firms as sources of risk;

To me, (1) and (3) seem to miss the point of separate accounts. Pension plans and institutional investors usually choose a separate accounts strategy to have greater control over their investments. The active involvement of the separate account holder acts as a control against the asset manager reaching for yield or using excessive leverage.

Of course, the findings in the Report do not mean that the big asset managers are imminently subject to additional regulatory oversight. There is a lengthy process for designated a firm as “systemically important.” However, this report could lead to adverse regulation that might adversely impact the separate account business of large asset managers, including those with real estate investment management platforms.

References:

Make Sure You Have the Right Ticker Symbol

tweeter

Perhaps you’ve heard the news that Twitter is going public. So you see that TWTR is already heading up fast so you but some. There is a trading frenzy. The stock is doubling in price, and then again, and again. Great offering. Just one problem. You bought stock in the defunct Tweeter Home Entertainment Group. It used to trade on the TWTR symbol.

When companies file for bankruptcy, the Financial Industry Regulatory Authority typically adds the letter Q to the existing ticker. That frees up the symbol for potential use by another company. So TWTR became TWTRQ when Tweeter filed for bankruptcy in 2007 (and again in 2008).

Apparently some investors were not paying close attention. The stock skyrocketed 684% on Friday. The price started at 0.018 and closed at 0.05 after rising as high as 0.15. Over 14 million shares had traded.

FINRA stepped in and stopped trading because the trading activity “demonstrated a widespread misunderstanding related to the possible initial public offering of an unrelated security, which … has caused a major disruption in the marketplace.”

Maybe it was just a data entry error that trigger the onslaught with others jumping on board. Maybe someone though Twitter would have to buy the ticker symbol from Tweeter so stockholders could see some value.

The question is why is the stock still hanging around. The company sold substantially all of its assets on July 31, 2007. There was brief and failed revival that blew up in December 2008.Presumably by now all of the AP And AR have run through the system.

I remember Tweeter as the special store to buy fancy and expensive audio equipment. All that hi-fi went away as the difference is sound quality diminished as digital took off. The iPod made the fatal blow.

Now the stock is just hanging around for shady traders and traders who get the wrong ticker symbol.

References:

Compliance Bricks and Mortar – The Shutdown Continues

black bricks

“The definition of insanity is continuing to do the same thing over and over, and then expecting different results.”

The US Congress continues to show it’s inability to operate as it has been unable to pass a bill that will fund the operations of the federal government. A big chunk of Congressmen want overturn the Affordable Care Act. The House of Representatives has passed forty bills that repeal the law. Forty times it has passed in the House and Forty times it has died in the Senate. Now they have tried again and harnessed the repeal of the law to the funding bills. Insanity.

Enough ranting. Here are some the compliance-related stories that recently caught my attention.

If One Bad Actor Spoils The Whole Barrel, What’s An Issuer To Do? by Keith Paul Bishop in California Corporate & Securities Law

The Jackson Five had it wrong. Under the SEC’s recently adopted Rule 506(d), one bad actor can indeed spoil the whole bunch. To some extent issuers can exercise some control over who becomes or remains a covered persons. However, an issuer may not be able to rid itself of all bad actors.

TD Bank To Pay $52.5 Million In Fines To Regulators Over Role In Rothstein Ponzi Scheme by Jordan D. Maglich in Ponzitracker

TD Bank was the primary banking institution used by Rothstein while he sold over $1 billion in purportedly-discounted pre-lawsuit settlements to investors for several years until October 2009. Potential investors were told that the settlements had already been deposited into a separate trust account in their name at TD Bank, and were provided so-called “lock letters” signed by Spinosa indicating that distribution of the funds was restricted only to the investor named in the lock letter. Spinosa also participated in at least one conference call with potential investors in which he supplied scripted answers to a series of Rothstein’s questions. In total, Rothstein raised approximately $1.4 billion from investors.

Crowdfunding v. Rule 506(c) Offerings by Joe Wallin in Startup Law Blog

Rule 506(c) offerings are not crowdfunding offerings under the JOBS Act.  Crowdfunding is embodied in Title III of the JOBS Act. The repeal of the ban on general solicitation in all accredited investor Rule 506 offerings appears in Title II of the JOBS Act.  So, the SEC’s repeal of the ban on general solicitation is not what is referred to as crowdfunding under the JOBS Act.

Toward a New SEC Enforcement Doctrine by Thomas O. Gorman in SEC Actions

New SEC Chair Mary Jo White has launched a new get tough policy. She modified the much discussed and often criticized “neither admit nor deny” settlement policy of the agency. Now she has outlined a new policy centered on a series of basic principles which will govern SEC enforcement. While many of those principles are familiar, the key will be how they implemented to achieve the Commission’s statutory mission and goals.

Shutdown

Sorry folks. The federal government is closed. The moose out front should’ve told you.

park's closed

Not exactly.

The Securities and Exchange Commission is still open and operational. The SEC’s current operational plan in the event of an SEC shutdown is available here (pdf). It’s not clear from reading this what will be operational and what is discontinued.

That’s in part because the SEC has a carryover balance that will allow it become fully operational for a few weeks. But at some point, if Congress can’t find it’s way out the paper bag it’s in, operations will start being shutdown.

Other parts of the government are shutting down. I expect it will be a bit easier commute into the District this morning. They will pass the Tea party Republicans holding their breath and not willing to pass a funding bill unless the Affordable Care Act is defunded or delayed.

Unfortunately, even if a funding bill is passed, we may see this battle again when the debt ceiling needs to be raised in a few weeks.