Creating Investment Product From Big Data

January 21st, 2015

China Securities Index Company, a joint venture between the Shanghai and Shenzhen Stock Exchanges, is launching an index which incorporates online sales data from Alibaba, China’s largest online commerce company.  The index represents an innovative use of big data in the creation of investable product.

The index is launching on January 21st with over four years of historical data dating from December 31, 2009.  The index will select stocks based on three factors: a valuation measure comprised of metrics such as price to earnings and price to sales; a technical analysis measure incorporating various technical analysis metrics; and a big data measure derived from Alibaba online sales data.

The index methodology will use Alibaba’s online sales data to rank industry sectors in terms of sales growth, price and supply-demand.  The industry values will be apportioned to individual stocks based on their industry market share.

The online sales data is being provided by Alipay Information Service Platform, a subsidiary of Ant Financial Services Group, an affiliate of Alibaba Group.  The data is processed by Hundsun JuYuan Data Service Co., Ltd, a Chinese fintech company that provides financial software and data. Alipay clears 80 million transactions per day, and in one day last year processed $9.3bn of transactions.

Here is the link to the CSI index announcement: http://www.csindex.com.cn/sseportal_en/csiportal/open_anno.jsp?url_s=/sseportal_en/csiportal/gywm/gsdt/20141226_1_en.html

Our Take

Creating investment product from research can be a lucrative business model as the recent sale of technical analysis firm Dorsey Wright to NASDAQ has shown.  Creating investment product from big data is a logical corollary, which will add to the attractiveness of big data to financial markets.  Firms which are brokering big data to financial markets participants might be in a position to benefit from the trend.

The action by China Securities Index Company also signals that thought leadership on investment product is not the exclusive property of established index providers.  Similarly the volume of transactions on Alipay promises to dwarf any of the current western online sales leaders.  China’s big data will be big indeed, and it will be mined and exploited by new Chinese competitors.

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DOJ: Appeals Court Got It Wrong In Insider Trading Reversal

January 19th, 2015

In a December 10th ruling, a federal appeals court reversed two key insider trading convictions.  However, in a new criminal insider trading case against 5 stockbrokers who traded on inside information, the DOJ argues that the appeals court was “dramatically wrong” in its ruling, suggesting that it is considering appealing the landmark ruling.

IBM Insider Trading Case

The Justice Department’s comments came in an insider trading case against four stockbrokers – Trent Martin, Thomas Conradt, David Weishaus and Daryl Payton – who admitted to trading on tips about IBM Corp.’s $1.2 billion purchase of software company SPSS Inc.   The fifth man, Benjamin Durant, pleaded not guilty.

The inside information purportedly came from a lawyer working on the deal who told his friend, Trent Martin, about it not expecting that Martin would pass the tip on to others or would trade on it himself.  Martin told his roommate, Conradt, who in turn shared it with stockbrokers Payton, Durant and Weishaus. The government charges that the five accused parties made more than $1 million from the tip.  The lawyer wasn’t charged with wrongdoing.

The judge presiding over the IBM case, U.S. District Judge Andrew Carter, told the defendants that he might throw out their guilty pleas because of the appeals court’s December 10th reversal.  The judge also delayed the start of a trial for Durant, who pleaded not guilty, until February 23rd.

In addition, the judge gave federal prosecutors until Jan. 23 to convince him that, given the appeals court ruling, he should not throw out their guilty pleas, noting he was “doubtful it’s going to succeed.”

The case is the U.S. versus Conradt, 12-cr-00887, U.S. District Court, Southern District of New York (Manhattan).

DOJ Response

In a court filing, government prosecutors explained that the appeals court decision shouldn’t affect the IBM case because the four men admitted to “misappropriating” or stealing the information. They also contend that the government shouldn’t also have to show that any personal benefit was provided for the inside information.

In commenting about the appeals court’s decision, assistant U.S. attorneys Jessica Masella and Andrew Bauer wrote that it “wrongly narrows” who can be prosecuted for obtaining nonpublic information from a company insider.

They added that the ruling “dramatically (and in our view, wrongly) departs from 30 years of controlling Supreme Court authority and, in so doing, legalizes manipulative and deceptive conduct that no court has ever sanctioned.”

Assistant U.S. Attorney Masella told Judge Carter that her office was consulting with Justice Department officials on whether to challenge the appeals court’s decision. Prosecutors are considering asking for a rehearing of the case before a full panel of Manhattan judges.  If the government’s attempt at the full U.S. Court of Appeals fails, it might seek a review by the U.S. Supreme Court.

Appeals Court Ruling

The entire IBM insider trading case against the 5 defendants turns on a recent appeals court ruling.  Read here for more details.  http://integrity-research.com/cms/2014/12/insider-trading-reversal-deals-gov%E2%80%99t-major-blow/

On December 10th, 2014 the United States Court of Appeals for the Second Circuit in Manhattan overturned two of the government’s insider trading convictions achieved in the past few years, against hedge fund managers Todd Newman and Anthony Chiasson.

The court of appeals agreed with the defendants that they could not be found guilty of insider trading given the government’s lack of evidence that the corporate insiders at Dell and Nvidia provided inside information in exchange for a personal benefit.  Furthermore, the court concluded that even if the tippers had received a personal benefit, there was no evidence Newman or Chiasson knew about such benefit to prove they were participants in the tippers’ fraudulent breaches of fiduciary duties.

Some suggest that the appeals court ruling could be extremely good news for other insider trading cases awaiting appeal.  Michael Steinberg, of SAC Capital Advisors was also convicted of insider trading last year, and the judge who provided “erroneous instructions” to the jurors in  Newman’s and Chiasson’s trial was the same who presided over Steinberg’s case — Judge Richard J. Sullivan.

Integrity’s Take

Judge Carter’s instructions in the IBM / SPSS insider trading case make it clear that last month’s decision by the Second Circuit Court of Appeals to overturn the Chiasson and Newman convictions will make it considerably more difficult for the U.S. Government to successfully win insider trading cases in the future.

The real question now is whether the Department of Justice feels strongly enough to appeal this decision.  We think this is very likely as allowing the appeals court decision to stand could undo many of the gains that the DOJ has won over the past few years against hedge funds and other white collar criminals.

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Lucrative Sale to Nasdaq Validates Dorsey Wright Strategy

January 14th, 2015

Nasdaq announced that it is acquiring technical analysis provider Dorsey, Wright & Associates, LLC (DWA).   However, the motivation for the purchase is not DWA’s research, but its 17 ETFs and $5.5 billion in assets under management.  DWA is a poster child for diversifying research into investment products.

Nasdaq will acquire DWA for $225 million funded through a mix of debt and cash on hand.  We estimate the valuation at between 5x and 6x revenues.  Could a technical analysis firm ever command such a generous valuation on its own?  No, the secret of Dorsey Wright’s success has been its well-executed strategy of creating investable products from its research.

Dorsey Wright & Associates was founded in 1987 and targeted its technical analysis platform to financial intermediaries, primarily retail brokers.  The firm has 22 employees, most based in Richmond VA with 4 in Pasadena CA.  Its research covers 40,000 stocks, funds, and ETFs globally.

DWA has developed a sophisticated array of investment products derived from its research.  DWA partnered with PowerShares to develop a series of ETFs based on DWA indices driven by stocks with high relative strength relative to their sectors.  Its largest ETF, the $1.6 billion PowerShares DWA Momentum Portfolio (NYSE:PDP) has outperformed the S&P 500 index since inception in 2007 and achieved a top-decile ranking among ETFs in its Morningstar category.

DWA is the sub-advisor on two co-branded Arrow Funds mutual funds.  The firm also acts as a sub-advisor on unit investment trusts marketed by First Trust based on DWA indices.  Last year DWA launched the First Trust Dorsey Wright Focus 5 (NASDAQ:FV), which became the most successful ETF launch during 2014 by attracting more than $1.2 billion in assets in less than 10 months.

DWA  has even issued last year a 7 year market linked CD which is tied to one its proprietary indices.  It also manages separate accounts affiliated with smaller brokerages through its asset management affiliate.

A majority of the company was sold in 2011 to Falfurrias Capital Partners, a Charlotte, N.C.-based private equity firm founded by former Bank of America Chairman and CEO Hugh McColl Jr. and former Bank of America CFO Marc D. Oken.  The sale to NASDAQ was prompted by the private equity firm desiring an exit, and the majority of the sale proceeds will go to Falfurrias.  In 2011, DWA had $1.7 billion in AUM and a primary motivation for the sale to private equity was to scale the asset management business further.

Read more: http://www.nasdaq.com/press-release/nasdaq-to-acquire-dorsey-wright–associates-20150105-00298#ixzz3O2yNb3R7
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Wall Street Job Outlook Ends 2014 On Upbeat Note

January 12th, 2015

Layoffs at Wall Street banks and brokerage firms dropped for the second month in a row in December 2014, according to a private jobs report.  New hiring, on the other hand, posted a meager gain in December following a surge the prior month as Wall Street firms continued to expand their payrolls to support higher M&A activity.

December Challenger, Gray & Christmas Report

According to the Challenger, Gray & Christmas monthly Job Cuts Report released last week, the financial services industry saw a 25% drop in planned layoffs from 657 layoffs announced in November to 490 layoffs announced in December.  The December layoff total was 210% below the number of announced layoffs reported in the same month in 2013.

Throughout the year, Wall Street firms have announced 27,443 layoffs, 55% less than the 60,962 layoffs announced during 2013.  It is important to note that the number of Wall Street layoffs in 2014 was the lowest annual total since 2010 when 23,996 layoffs were announced during the year.

Despite the decline in layoffs, financial services firms announced a meager 283 new jobs to be filled during December, a 94% drop from November’s 4,620 new jobs reported – which was one of the most robust new hiring totals seen in the past few years.  On an annual basis Wall Street firms have announced plans to hire 7,632 new positions, 72% higher than the 4,011 new positions announced during 2013.

A Few Banks Shed Workers in December / Early January

In December, Deutsche Bank announced that it had cut or moved up to 10 London-based credit default swaps traders as the firm aims to trim its fixed income business to comply with new regulations.  Another 3 to 5 swaps traders either had their positions eliminated or they were moved to other jobs as the bank eliminated at least 20 positions across its markets business.

Standard Chartered, the U.K. based, Asia-focused lender, announced last week that it plans to close its cash equities, equity research and equities capital markets business.  The closing of these divisions, which have been unprofitable, will result in 200 jobs being cut, primarily in Asia. The move will save the bank $100 million, it said in a statement.  In its retail bank, Standard Chartered have cut 2,000 staff in recent months, with plans to eliminated another 2,000 mostly Asia-based positions during 2015, mainly by not replacing departing staff.

Impact on the Research Industry

It is clear that the employment picture turned markedly better in 2014 with lower layoffs and an increase in hiring which was supported, in large part, by stronger M&A activity which offset weakness in cash equities and fixed income.   If this trend continues, we would not be surprised to see investment banks increase hiring in their equity research departments as a way to compete for M&A deals.

However, we don’t think most sell-side firms will open the hiring floodgates in their research departments as weak equity commission volumes and increased regulatory pressures should prompt a cautious approach to hiring.  For example, ESMA’s recent proposal to require buy-side firms to budget their third-party research spending could put downward pressure on payments for sell-side research – a development that will mitigate some of the interest in staffing up their research operations.

When all is said and done, we believe that the hiring outlook for research analysts, sales people, and other research support staff at sell-side and independent research firms should improve this year when compared to 2014.  However, we don’t think the employment picture will be particularly robust in 2015.

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What’s Ahead for 2015?

January 7th, 2015

It is time for us to squint into the crystal ball for 2015…

Equity commissions

2014 provided a welcome respite from the inexorable decline of equity commissions.  US shares traded were flat, with volumes up 2% from the previous year.

Does this portend a floor for commissions, with volumes increasing?  Unfortunately, we think not.  We fear that the underlying trend is negative, which will only be exacerbated if the six year equity bull market runs out of steam.  Of course, we will be happy to be proven wrong.

M&A/Consolidation

2014 was a notable year for research-related M&A transactions.  The bellwether was Evercore’s purchase of ISI for $440 million, but also notable were Sidoti’s S-1 filing,  Capital Economics’ generously valued capital infusion and MSCI’s bargain purchase of GMI Ratings.

The bottom line is that investment research is saleable again, although the valuations are, with some exceptions, not that rich.  We expect to see more transactions in 2015.  Will this be the year Silverlake takes GLG public?

Regulatory

One of the major headlines for 2014 was the increasing aggressiveness of European regulators, led by the UK Financial Conduct Authority, in regulating equity research commissions.  The UK now operates under a regime that bans commission payments for vanilla corporate access, requires valuation of bundled research and forbids payment for research not used.  The new guidelines attempted to implement more rigorous budgeting and procurement processes for research.

If currently proposed MiFID II regulation holds up, budgeting will become a European regulatory requirement as of 2017.  Asset managers will have to decide how much they want to pay each research provider, cap payments at that amount, and get client signoff on any increases.  We expect that more rigorous research budgeting will become the norm before the European regulations take effect, and, like CSAs, will be adopted globally.

Insider trading convictions went into reverse in 2014, but we don’t expect that compliance processes will change.  Greater compliance due diligence is a now a fact of life.

CSAs

CSAs will continue to grow, both from new adoption and from increased commission volume being placed through CSAs as asset managers seek to stretch commission dollars.  The pending European regulation practically makes CSAs mandatory because asset managers will be required to set up “research payment accounts” which are for all intents and purposes CSAs.

International Expansion

2015 will be a good year to be global, particularly for independent research providers.  Demand for independent research has been growing in Europe and Asia, and the pending European rules on research budgeting will be favorable for independent research.  We expect some M&A transactions in 2015 to reflect cross-border expansion.

Primary Research

Expert networks have made a remarkable comeback from the doldrums of 2011, setting new highs for revenues and hiring frenetically.  We expect that primary research will continue to prosper in 2015 as insider trading concerns continue to wane.  Primary research remains a major source of alpha.  Given the financial pressures on investment banking research, most banks are cutting back on primary research, leaving the field increasingly open and attractive.

Big Data

Technology is transforming investment research, and this trend will continue in 2015.  Firms like Kensho are trying to automate the research process, similar to the way HFT has automated trading.  Big data is an enticing and still relatively unmined source of alpha.  Hedge funds and research providers are investing in new data sets and analytics.  Much of the data is still ‘green’ but it is maturing quickly given the volumes.  This will remain one of the most vibrant areas for innovation.

Conclusion

A quick look at our market conditions survey (which is still in progress) suggests that conditions in 2014 weren’t bad for many independent research providers.  Based on responses so far, the median estimated growth in 2014 revenues was 10% and the mean was close to 17%.  Respondents are a little more subdued when looking toward 2015 with mean expected revenues projected to be closer to 15%.  Certainly the environment is better than it was three years ago.  [It is not too late to participate in our market conditions survey; go to http://questionpro.com/t/AKpHKZR3oQ]

Although we are bearish on the core trend in equity commissions, we see bright spots going into 2015: a relatively quiescent regulatory environment (relative to previous years), improved M&A activity, positives for CSAs and global expansion, and a fast pace of technological innovation.

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Outlook for the Buy-Side and Its Impact on the Research Biz

January 5th, 2015

Portfolio managers and analysts working at asset management firms are the key consumers of the investment research services produced by sell side investment banks and independent research providers.  Thus to understand where the research business should head in the next few years, it is important to grasp the various factors impacting the asset management business and the likely growth of this industry.

Forecast for the Asset Management Industry

According to PwC, global AuM in the asset management industry is projected to grow from current levels to $101.7 trillion by the end of 2020, representing a compound annual growth rate of nearly 6%.  The fastest growing regions of the world are estimated to be Latin America (12.5% CAGR), Middle East & Africa (11.9% CAGR), and Asia Pacific (9.8% CAGR).  North America (5.1% CAGR) and Europe (4.4% CAGR) are expected to grow at a more modest pace.

In a recent survey conducted by PwC, more than 40% of asset managers in developed countries looking to grow their businesses outside their home countries believe the most important geographical area of focus in the future will be the South America, Asia, Africa, Middle East region (SAAAME).  This view is consistent with World Bank forecasts that GDP growth in East and South Asian countries will outperform developed nations over the coming decade.  PwC forecasts that the growth in AuM in Asia Pacific will result from a significant increase in mass affluent and high net worth individuals throughout the region.

Asset Management Industry Forecast – By Region ($ trillions)

Source: PwC analysis.  Past data based on Hedge Fund Research, ICI, Preqin, Towers Watson and The City UK data.

One of the recent trends in the asset management industry that is expected to pick up steam in the coming years is the growing popularity of passive investments as many investors adopt strategies to generate beta separately from alpha. Another factor which is expected to prompt growth in passive investment is regulatory pressure to increase cost transparency with active investments – a factor that will lead many investors to look for lower cost ways to generate market returns.

Based on PwC’s forecasts, passive investments are expected to grow from $7.3 trillion (or 11.4% of AuM) in 2012 to $22.7 trillion (or 22.3% of AuM) by the end of 2020.  As you can see from the chart below, by 2020 institutional investors will hold the largest share of passive investments via pension funds ($12.2 trillion), while retail investors will hold a slightly smaller share of passive investments through mutual fund vehicles ($10.5 trillion).

It is important to note that active investments at both mutual funds and pension funds are expected to shrink as a total share of AuM from 2012 to 2020.  Mutual fund assets invested in active funds are projected to fall from 36.9% of AuM in 2012 to 30.3% in 2020, while active pension fund assets are estimated to shrink from 41.6% in 2012 to 34.7% in 2020.

Despite the growth in beta strategies via passive investments, demand for alpha generating active management is expected to continue to grow.  According to PwC, alternative investments (hedge funds, private equity, real estate funds) should expand from $6.4 trillion (10% of AuM) in 2012 to $13.0 trillion (12.8% of AuM) in 2020.  The growth in alternative investments should be supported by shrinking fees and relative outperformance when compared to other investment options.

Asset Management Industry Forecast – By Investment Type ($ trillions)

Source: PwC analysis.  Past data based on Hedge Fund Research, ICI, Preqin, Towers Watson and The City UK data.

Pension fund mandates are also projected to drive some of the AuM growth through 2020 as the switch from pay-as-you-go systems to defined contribution plans in fast growing countries produces a surge in retirement assets.  PwC estimates that pension fund mandates will grow 5.7% per year from $33.9 trillion in 2012 to $56.5 trillion in 2020.

Key Trends Impacting the Asset Management Industry

Despite experiencing moderate growth in assets over the coming few years, the global asset management industry is expected to face a number of pressures which will significantly impact the competitive position of individual players as well as the profitability of the industry as a whole.  These include:

  1. Regulatory Pressures: AIFMD, UCITS V, VI, and VII, EMIR, PRIPS, MiFID II and III, Shadow Banking I and II, and Dodd-Frank have all placed greater regulatory demands on asset managers – forcing changes in fund product features, service provider arrangements, regulatory and investor disclosure, distribution channels, compliance and risk management functions, and in some cases business models.  It is highly unlikely that this regulatory focus will decrease in the coming few years, forcing asset management firms to increase the number of compliance staff they employ in order to address these regulatory requirements.  This trend will increase the costs of doing business for asset management firms.
  2. Changing Competitive Landscape: Customer demand for new products will change the competitive landscape as traditional asset managers won’t retain the competitive advantage they have had for years.  It is likely that providers of nontraditional assets like hedge funds, private equity funds, etc. will compete with traditional managers by offering some of their staple products like long-only funds, multi-asset, or other specialty products.   In addition, the asset management industry could well see new competitors enter from outside the business like social media or other technology companies who decide to leverage their customer base or core capabilities to offer innovative new asset management services.
  3. Digital & Data Revolution: Over the next decade, digital technologies and expertise in big data management and analysis will impact the asset management industry, much as it is currently impacting other industries.  This will enable many asset management firms to move to enterprise wide risk management, data sharing, and market-driven product development throughout the firm.  While this trend will inevitably lead to increased technology investments over the near term, it is likely to result in increased productivity and business efficiencies over the intermediate to long-term.
  4. Globalization: Customer demand for greater investment diversification and management’s search for new sources of growth will lead many domestic asset management firms to become global in scope.  This has been evident among US and UK asset managers over the past decade, and should start to take place with Asian managers in the coming decade.  This presence in multiple geographic markets, while a source of new clients and growing revenue, also brings with it operational complexity and higher costs.

What This Means for the Research Business

Clearly, the overall asset management industry faces a period of moderate AuM growth and significant cost pressures which should have a meaningful impact on participants in the research business.  We suspect that increased regulatory pressure and investors’ shift from active to passive investments will have a large impact at mutual funds, making this market extremely cost conscious.  This should lead mutual funds to be cautious in increasing their budgets for external research provided by sell-side or independent research firms.

As we mentioned earlier, hedge fund firms should experience robust AuM growth in the coming years as many investors continue to look for concentrated strategies to generate alpha.   Even with the cost pressures expected in the industry and the shrinking of management fees, we expect that hedge funds will increasingly become the most important customer base for sell-side and independent research providers.

While we expect that buy-side investors in North America will continue to be the largest revenue source for third-party research firms, we also expect that over the next 5 – 10 years, asset managers in Asia, Latin America, and the Middle East / Africa will increasingly become a larger percentage of sell-side and independent research firms’ business as buy-side firms in these regions grow in both number and size.

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SEC Finds Conflicts of Interest at Ratings Agencies

December 29th, 2014

The SEC recently issued a report which revealed various conflicts of interest at US ratings agencies including allowing a trade group to impact their ratings criteria, letting senior credit officers review private market share data, and generally failing to follow their published ratings methodology.

Report Background

On December 23, 2014, the SEC’s Office of Credit Ratings issued their fourth annual examination of Nationally Recognized Statistical Rating Organizations.  This report, established as a part of the Dodd-Frank financial reform law, evaluated US ratings agencies’ practices from 2013.

While the report didn’t name specific ratings agencies, it did assess the overall practices of “large firms” (Standard & Poor’s, Moody’s Investors Service or Fitch Ratings) and “small firms” (e.g. AM Best, Egan-Jones Rating Company, Morningstar, DBRS, Inc., etc.).

SEC Chair Mary Jo White explained the purpose of this annual report, “The SEC’s enhanced oversight of NRSROs, informed by risk assessment, regular examinations and policy considerations, provides increasingly robust and effective oversight of the industry, as reflected by overall improvements in compliance, documentation, and board oversight.”

Findings

Staff at the SEC’s Office of Credit Ratings made a wide range of recommendations for improvement in various areas at the NRSROs that were reviewed, including:

  • Use of affiliates or third-party contractors in the credit rating process;
  • Management of conflicts of interest related to the rating business operations;
  • Adherence to policies and procedures for determining or reviewing credit ratings.

For example, after reviewing the e-mails at one of the “large raters”, the SEC found that employees on the business side of that firm worked in a concerted fashion to change its ratings criteria to appease one industry trade group.  This was based on business and market share conditions for the ratings agency.

In addition, at one of the “large firms”, the chief credit officer reviewed nonpublic information about its own revenue, financial performance, and market share even though its compliance policies bar these employees from obtaining this information.  This prohibition is to keep agencies from issuing ratings in order to increase market share or generate more revenue.

Also, the SEC found that one large firm and four smaller ratings agencies did not follow their own ratings methodologies.

During the 2014 examinations, the SEC staff observed marked improvements at the NRSROs versus prior years in a range of areas, including:

  • Compliance resources, monitoring, and culture;
  • Documentation and resources for criteria and model validation;
  • Document retention;
  • Board of directors or governing committee oversight.

“The findings and recommendations in the 2014 examination report demonstrate the impact of rigorous oversight by the SEC and regular examinations by the Office of Credit Ratings,” said Thomas J. Butler, Director of the SEC’s Office of Credit Ratings.

Integrity’s Take

The results of the SEC’s 2014 report revealed that, while the ratings agencies are becoming more rigorous about a number of compliance issues, they are continuing to struggle in a few areas related to conflicts of interest.

Obviously, US ratings agencies will need to continue to try to transform both their culture and practices in order to regain the trust and credibility they once had among financial market participants.  Unfortunately, rebuilding this trust is not something that will be accomplished overnight.

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ESMA Backs Away From Research Commission Ban, BUT…

December 22nd, 2014

As we predicted, the revised MiFID II rules have backed away from an outright ban on paying for research with client commissions.  BUT, and this is a big but, the proposed MiFID II regime has very stringent conditions on the ability to pay for research with client commissions which go further than any regulator has gone so far, including the aggressive UK regulators. If adopted, and chances are good it will be, the research industry will be changed significantly, not only in Europe but globally.

The Revised MiFID II Guidelines

The European Securities and Markets Authority (ESMA), the European regulator whose members are the financial markets regulators in each of the 28 member states, has released revised technical advice on the implementation of the Markets in Financial Instruments Directive (MiFID II). The advice can be found here. The relevant sections for investment research are pages 130 – 134, which are the discussion, and pages 139 – 141, which are the proposed regulatory language.

Even though the majority of respondents to ESMA’s initial Consultation Paper opposed the idea that research is an inducement, ESMA insists that bundling research and execution commissions represents an indirect payment structure which qualifies as an inducement. However, investment firms may continue to use client commissions to pay for research provided they set up a research payment account funded by specific research charges billed to the investment firms’ clients.

The research charges funding the research payment accounts must be based on a research budget set by the investment firm and cannot be linked to the volume and/or value of transactions executed on behalf of the clients.

Research Budgeting

Under the proposed rules, the investment firm must agree with each client the research charge as budgeted by the firm and the frequency of the research charge. The investment firm may only increase the research budget with the client’s written agreement. If there is a surplus in the research payment account at the end of a period, the surplus should either be rebated or applied to the following period.

Research budgets must be managed solely by the investment firm with senior management oversight. The budgets need controls including a clear audit trail of payments made to research providers and how the amounts were determined.

The investment firm should regularly assess the quality of the research purchased based on robust quality criteria and its ability to contribute to better investment decisions. Firms will also need to address the extent to which purchased research benefits clients’ portfolios taking into account the portfolios’ various investment strategies. Research costs need to be allocated as fairly as practical to the various clients’ portfolios. The whole process must be documented in a written policy.

CSAs

Commission sharing agreements (CSAs), which allow asset managers to pay an executing broker for trade execution while separately allocating a portion of the commission to pay a research provider, will be integral to the proposed MiFID II regime. CSAs will be the primary mechanism for implementing the research payment accounts described in the technical advice.

ESMA states that commission sharing arrangements (CSA’s) have elements that address the conflict of interests between brokers and portfolio managers in respect of research. However, ESMA makes it clear that CSAs alone do not meet the new MiFID II requirements: “The current use of CSA’s by industry still enables amounts charged for research by the investment firm to be determined by the volume of transactions of the investment firm with the executing broker.” Hence the emphasis on budgeting in the technical advice.

Investment Banks

ESMA takes a couple of shots at investment banks. First, it says that research pricing should be unbundled, with brokers providing separately identifiable charges for research. However, investment banks are not governed by MiFID II, so the technical advice threatens separate regulation: “Future ESMA guidelines may also be useful in this area.”

ESMA also calls on the European Commission to address the conflicts between investment banking and research, an area where European regulation lags the U.S.

Timeframe and Scope

The revised draft language in the latest ESMA release will be open for comment until March 2, 2015. After that, ESMA will submit its final technical advice for endorsement by the European Commission by January 2016 and the final rules will go into effect from January 3, 2017.

MiFID II applies to investment firms managing separate accounts. ESMA advises the Commission to include the new rules for research payments into UCITS and AIFMD so that the same regulations pertain to managed funds and hedge funds.

Our Take

Although many are relieved that a ban on research commissions has been averted, the reality is that the proposed MiFID II regime will radically change the research payment process. First there is the matter of budgeting, a rare practice as the UK Financial Conduct Authority (FCA) found during its thematic review earlier this year . Asset managers will need to determine in advance how much they are willing to pay each broker who supplies research, and cap payments at that amount. The aggregated budget amounts will determine the research charges levied on an investment firm’s clients.

Which leads to the second big change: signoff from clients. To increase the research budget, investment firms will need written agreement from clients. If performance is good, presumably clients will be accommodating. Getting approval during difficult markets or when providing indifferent returns will be more challenging. This will make it harder to grow research payments.

Conversely, the budget process will tend to provide a floor as well as a ceiling on research revenues. Asset managers have an incentive to spend all they budget rather than rebate the excess or roll it over to the next year.

Administratively, asset managers will need to track research commissions down to the fund level, even though overall budgeting will be done at an aggregated level. Broker votes as currently constituted have some use, provided they now allocate the research charges rather than overall commissions, but they do not currently address the budgeting and client signoff processes.

Many asset managers think of the vote as allocating a percentage of commissions. This way of thinking is obsolete. Asset managers will need to think of the absolute amounts paid away, and presumably this will lead to thoughts of relative value received from the various providers.

In theory, if investment banks provided explicit research pricing as ESMA is encouraging, broker votes would not be necessary. However, while banks may provide marginally more transparency, we doubt that it will be sufficient to obviate the broker vote anytime soon. Also, broker votes help to satisfy the requirement of assessing the quality of research provided, even though votes do not address the benefits at the client portfolio level.

Client behavior is a wild card in the new budgeting/approval process. Currently, pension funds that receive the Level II commission disclosures in the UK simply file them away. Will asset manager clients become more engaged in the new regime? They will need to sign off on any increases, but otherwise may as indifferent as they are to the Level II disclosures.

Balky clients do raise the ‘free rider’ problem for asset managers. If a client refuses an otherwise approved increase in the research budget, does the recalcitrant client get a different level of service?

The new regime will be positive for CSAs, which will become nearly mandatory. CSAs will be the preferred vehicle for managing the research payment accounts.

A big issue not addressed by ESMA is VAT. Currently, bundled research is exempt from VAT. The MiFID II regime will explicitly unbundle research payments, making research vatable. This may be the biggest concern for research providers, potentially lopping off 20% of research payments at one whack.

Investment banks will not benefit from the new guidelines, except as CSA brokers. Unbundling hurts equity commission revenues. Adding insult to injury, ESMA is threatening tougher conflict rules between banking and research. On a relative basis independents benefit from a more level playing field, but they are also subject to the overall constraints on payments from the budgeting process. Research becomes even more of a market share game than it is today.

Although there is yet another comment period ahead, we suspect the final rules will be close to the current draft rules. ESMA has backed away from the full ban as European legislators requested, and it is proposing guidelines that will accommodate CSAs and improve transparency. Asset managers will winge about the administrative burden, but ESMA can simply respond, ‘if you don’t like the process pay out of your own pocket’. VAT is a big concern, but unlikely to be a deal breaker.

The proposed MiFID II payment regime will likely have a bigger impact on non-EU markets than an outright ban. If ESMA had stuck with a ban, the likely response would have been regulatory arbitrage, as is happening now with the FCA’s ban on commission payments for corporate access. However, the budgeting/approval process will be adopted by global asset managers and implemented in all domiciles, U.S. included. It will take time, and the proposed regime would not go into effect for two years, but its effect will be profound and far-reaching.

As we predicted, http://integrity-research.com/cms/2014/11/mifid-ii-will-not-ban-research-commissions/ the revised MiFID II rules have backed away from an outright ban on paying for research with client commissions. BUT, and this is a big but, the proposed MiFID II regime has very stringent conditions on the ability to pay for research with client commissions which go further than any regulator has gone so far, including the aggressive UK regulators. If adopted, and chances are good it will be, the research industry will be changed significantly, not only in Europe but globally.

The Revised MiFID II Guidelines

The European Securities and Markets Authority (ESMA), the European regulator whose members are the financial markets regulators in each of the 28 member states, has released revised technical advice on the implementation of the Markets in Financial Instruments Directive (MiFID II). The advice can be found here. http://www.esma.europa.eu/system/files/2014-1569_final_report_-_esmas_technical_advice_to_the_commission_on_mifid_ii_and_mifir.pdf The relevant sections for investment research are pages 130 – 134, which are the discussion, and pages 139 – 141, which are the proposed regulatory language.

Even though the majority of respondents to ESMA’s initial Consultation Paper opposed the idea that research is an inducement, ESMA insists that bundling research and execution commissions represents an indirect payment structure which qualifies as an inducement. However, investment firms may continue to use client commissions to pay for research provided they set up a research payment account funded by specific research charges billed to the investment firms’ clients.

The research charges funding the research payment accounts must be based on a research budget set by the investment firm and cannot be linked to the volume and/or value of transactions executed on behalf of the clients.

Research Budgeting

Under the proposed rules, the investment firm must agree with each client the research charge as budgeted by the firm and the frequency of the research charge. The investment firm may only increase the research budget with the client’s written agreement. If there is a surplus in the research payment account at the end of a period, the surplus should either be rebated or applied to the following period.

Research budgets must be managed solely by the investment firm with senior management oversight. The budgets need controls including a clear audit trail of payments made to research providers and how the amounts were determined.

The investment firm should regularly assess the quality of the research purchased based on robust quality criteria and its ability to contribute to better investment decisions. Firms will also need to address the extent to which purchased research benefits clients’ portfolios taking into account the portfolios’ various investment strategies. Research costs need to be allocated as fairly as practical to the various clients’ portfolios. The whole process must be documented in a written policy.

CSAs

Commission sharing agreements (CSAs), which allow asset managers to pay an executing broker for trade execution while separately allocating a portion of the commission to pay a research provider, will be integral to the proposed MiFID II regime. CSAs will be the primary mechanism for implementing the research payment accounts described in the technical advice.

ESMA considers that commission sharing arrangements (CSA’s) have elements that address the conflict of interests between brokers and portfolio managers in respect of research. However, ESMA made it clear that CSAs alone do not meet the new MiFID II requirements: “The current use of CSA’s by industry still enables amounts charged for research by the investment firm to be determined by the volume of transactions of the investment firm with the executing broker.” Hence the emphasis on budgeting in the technical advice.

Investment Banks

ESMA takes a couple of shots at investment banks. First, it says that research pricing should be unbundled, with brokers providing separately identifiable charges for research. However, investment banks are not governed by MiFID II, so the technical advice threatens separate regulation: “Future ESMA guidelines may also be useful in this area.”

ESMA also calls on the European Commission to address the conflicts between investment banking and research, an area where European regulation lags the U.S.

Timeframe and Scope

The revised draft language in the latest ESMA release will be open for comment until March 2, 2015. After that, ESMA will submit its final technical advice for endorsement by the European Commission by January 2016 and the final rules will go into effect from January 3, 2017.

MiFID II applies to investment firms managing separate accounts. ESMA advises the Commission to include the new rules for research payments into UCITS and AIFMD so that the same regulations pertain to managed funds and hedge funds.

Our Take

Although many are relieved that a ban on research commissions has been averted, the reality is that the proposed MiFID II regime will radically change the research payment process. First there is the matter of budgeting, a rare practice as the UK Financial Conduct Authority (FCA) found during its thematic review earlier this year http://integrity-research.com/cms/2014/07/uk-regulator-supports-ban-on-research-commissions/ . Asset managers will need to determine in advance how much they are willing to pay each broker who supplies research, and cap payments at that amount. The aggregated budget amounts will determine the research charges levied on an investment firm’s clients.

Which leads to the second big change: signoff from clients. To increase the research budget, investment firms will need written agreement from clients. If performance is good, presumably clients will be accommodating. Getting approval during difficult markets or when providing indifferent returns will be more challenging. This will make it harder to grow research payments.

Conversely, the budget process will tend to provide a floor as well as a ceiling on research revenues. Asset managers have an incentive to spend all they budget rather than rebate the excess or roll it over to the next year.

Administratively, asset managers will need to track research commissions down to the fund level, even though overall budgeting will be done at an aggregated level. Broker votes as currently constituted have some use, provided they now allocate the research charges rather than overall commissions, but they do not currently address the budgeting and client signoff processes.

Many asset managers think of the vote as allocating a percentage of commissions. This way of thinking is obsolete. Asset managers will need to think of the absolute amounts paid away, and presumably this will lead to thoughts of relative value received from the various providers.

In theory, if investment banks provided explicit research pricing as ESMA is encouraging, broker votes would not be necessary. However, while banks may provide marginally more transparency, we doubt that it will be sufficient to obviate the broker vote anytime soon. Also, broker votes help to satisfy the requirement of assessing the quality of research provided, even though votes do not address the benefits at the client portfolio level.

Client behavior is a wild card in the new budgeting/approval process. Currently, pension funds that receive the Level II commission disclosures in the UK simply file them away. Will asset manager clients become more engaged in the new regime? They will need to sign off on any increases, but otherwise may as indifferent as they are to the Level II disclosures.

Balky clients do raise the ‘free rider’ problem for asset managers. If a client refuses an otherwise approved increase in the research budget, does the recalcitrant client get a different level of service?

The new regime will be positive for CSAs, which will become nearly mandatory. CSAs will be the preferred vehicle for managing the research payment accounts.

A big issue not addressed by ESMA is VAT. Currently, bundled research is exempt from VAT. The MiFID II regime will explicitly unbundle research payments, making research vatable. This may be the biggest concern for research providers, potentially lopping off 20% of research payments at one whack.

Investment banks will not benefit from the new guidelines, except as CSA brokers. Unbundling hurts equity commission revenues. Adding insult to injury, ESMA is threatening tougher conflict rules between banking and research. On a relative basis independents benefit from a more level playing field, but they are also subject to the overall constraints on payments from the budgeting process. Research becomes even more of a market share game than it is today.

Although there is yet another comment period ahead, we suspect the final rules will be close to the current draft rules. ESMA has backed away from the full ban as European legislators requested, and it is proposing guidelines that will accommodate CSAs and improve transparency. Asset managers will winge about the administrative burden, but ESMA can simply respond, ‘if you don’t like the process pay out of your own pocket’. VAT is a big concern, but unlikely to be a deal breaker.

The proposed MiFID II payment regime will likely have a bigger impact on non-EU markets than an outright ban. If ESMA had stuck with a ban, the likely response would have been regulatory arbitrage, as is happening now with the FCA’s ban on commission payments for corporate access. However, the budgeting/approval process will be adopted by global asset managers and implemented in all domiciles, U.S. included. It will take time, and the proposed regime would not go into effect for two years, but its effect will be profound and far-reaching.

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FINRA Says No to Re-Bankerizing Research

December 17th, 2014

In an echo of the 2003 Global Research Analyst Settlement, FINRA fined ten investment banks $43.5 million for allowing equity analysts to solicit investment banking business in connection with a proposed IPO for Toys ‘R’ Us (TRU).  Eight of the ten banks had participated directly in the Global Settlement.  Plus ça change, plus c’est la même.  However, FINRA’s actions make it harder for investment banks to monetize their research operations.  If banking research remains primarily funded by trading commissions, the future is not a happy one.

The 10 Banks

FINRA fined Barclays Capital (whose acquisition Lehman had been a Settlement participant), Citigroup, Credit Suisse, Goldman Sachs and JP Morgan $5 million each for violations of NASD Rule 2711, the research analyst conflict of interest rule.

Deutsche Bank, Merrill Lynch, Morgan Stanley and Wells Fargo were fined $4 million each, and Needham & Company was fined $2.5 million.  The banks consented to the fines but neither admitted nor denied the charges.

The Alleged Wrongdoing

FINRA alleges that each of the ten banks included their analysts in meetings their bankers held with TRU management and TRU’s private equity owners (Bain Capital, KKR and Vornado Realty Trust).  The meetings were set up to solicit the analysts’ views on key issues, including valuation factors, and to determine if the analysts were aligned with the views expressed by the firms’ investment bankers.  According to FINRA, each firm understood that the performance of their analysts at the presentations would be a key factor in determining whether the firm received an underwriting role in the IPO.

According to the settlement documents, each of the firms implicitly or explicitly offered favorable research coverage in return for a role in the IPO.  As an example, the unnamed analyst at Citigroup sent an email to a supervisor stating: “I so want the bank to get this deal!”  One of the private equity owners of TRU wrote that the bullishness of the Credit Suisse analyst was “off the charts.”  Most fervent of all, however, was the analyst at Needham, who wrote “I would crawl on broken glass dragging my exposed junk to get this deal.”

Rule 2711

FINRA charged the banks with violations of Rule 2711(c)(4), which prohibits participation by analysts in pitch meetings, and Rule 2711(e), which forbids the promise of favorable research.  Some of the banks were also charged with a failure to supervise, in violation of 2711(i), which outlines supervisory procedures.

Rule 2711(c)(4) states, “No research analyst may participate in efforts to solicit investment banking business. Accordingly, no research analyst may, among other things, participate in any ‘pitches’ for investment banking business to prospective investment banking clients, or have other communications with companies for the purpose of soliciting investment banking business.”

Under Rule 2711(c)(4), an analyst is allowed to communicate with an issuer during the solicitation period for due diligence purposes, but is not permitted to help solicit a role in the underwriting.   An analyst is prohibited from communicating views on the issuer, the issuer’s industry, valuation or comparable companies.

Rule 2711(e) states, “No member may directly or indirectly offer favorable research, a specific rating or a specific price target, or threaten to change research, a rating or a price target, to a company as consideration or inducement for the receipt of business or compensation.”

Reforms to Rule 2711

In 2012, the JOBS Act allowed analysts to participate in pitch meetings for Emerging Growth Companies, but the other Rule 2711 restrictions were not relaxed.  In other words, analysts could attend to the meetings but could not help efforts to solicit banking business.  The regulation begged the question of why bother to invite the analysts if they can’t help the bankers?

FINRA is also proposing to consolidate Rule 2711 into a new Rule 2241, with some minor changes.  One not-so-minor proposed change would be to reduce the current 15-day quiet period to 10 days prior to an IPO and 3 days after.  The comment period for the proposed changes expired December 16th.

Our Take

The 2003 Global Settlement weakened one the key business supports for investment research, the link to investment banking.  Post-settlement, research has been mainly funded by trading commissions.  However, with equity commissions increasingly under market and regulatory pressure, the temptation is very strong to “re-bankerize” research.  After all, why else would Evercore buy ISI?

The FINRA action throws cold water on the proposition of diversifying the research revenue base away from commissions, at least for U.S.-based research.  (Outside the U.S., analysts and bankers are permitted to be cozier.)  The weakened ties between banking and research makes it more difficult to monetize research in an environment of structurally declining commissions, increasing the likelihood of further rationalization of investment banking research operations.

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Insider Trading Reversal Deals Gov’t Major Blow

December 15th, 2014

Last week, a federal appeals court reversed two key insider trading convictions, in a decision which made it clear the government did not prove that a crime was committed.  More importantly, the court’s decision could have major implications on prosecutors’ ability to win insider trading cases in the future.

Background of Case

This case arises from the Government’s investigation over the past few years into suspected insider trading activity at hedge funds. At the initial trial in 2012, the Government presented evidence that a group of buy-side analysts exchanged material non-public information they had obtained from company insiders.

The Government alleged that these analysts received information from corporate insiders at Dell and NVIDIA disclosing those companies’ quarterly earnings before they were publicly released at various times in 2008.  These analysts passed the inside information to their portfolio managers, including Todd Newman of hedge fund Diamondback Capital Management and Anthony Chiasson of Level Global Advisors.  These managers in turn, executed trades in Dell and NVIDIA stock, earning approximately $4 million and $68 million, respectively, in profits for their respective funds.

In December 2012, Chiasson and Newman were found guilty of insider trading.  Subsequently, in May 2013, U.S. District Judge Richard Sullivan sentenced Newman to 54 months in prison and Chiasson received 78 months for their roles in what the prosecutor called a “criminal club” that netted them more than $70 million in illegal profits.

Appeals Court Decision

In its stunning 28 page decision, United States Court of Appeals for the Second Circuit in Manhattan overturned two of the government’s insider trading convictions, against hedge fund managers Todd Newman and Anthony Chiasson.

The unanimous decision by a three-judge panel was the first time that United States attorney in Manhattan, Preet Bharara, had one of his insider trading convictions overturned.  The appeal court’s rationale for this decision was based on two factors — an error by the trial judge in his jury instruction and insufficient evidence on the part of the government.

“We agree that the jury instruction was erroneous because we conclude that, in order to sustain a conviction for insider trading, the Government must prove beyond a reasonable doubt that the tippee knew that an insider disclosed confidential information and that he did so in exchange for a personal benefit.  Moreover, we hold that the evidence was insufficient to sustain a guilty verdict against Newman and Chiasson for two reasons.    First, the Government’s evidence of any personal benefit received by the alleged insiders was insufficient to establish the tipper liability from which defendants’ purported tippee liability would derive.    Second, even assuming that the scant evidence offered on the issue of personal benefit was sufficient, which we conclude it was not, the Government presented no evidence that Newman and Chiasson knew that they were trading on information obtained from insiders in violation of those insiders’ fiduciary duties.”

In its ruling, the appeals court consistently cited its reading of the US Supreme Court case Dirks vs. the SEC which has long been used in understanding the courts’ view of insider trading.  However, the appeals court went farther in its ruling to create a more defined line when assessing insider trading liability.

“In sum, we hold that to sustain an insider trading conviction against a tippee, the Government must prove each of the following elements beyond a reasonable doubt: that (1) the corporate insider was entrusted with a fiduciary duty; (2) the corporate insider breached his fiduciary duty by (a) disclosing confidential information to a tippee (b) in exchange for a personal benefit; (3) the tippee knew of the tipper’s breach, that is, he knew the information was confidential and divulged for personal benefit; and (4) the tippee still used that information to trade in a security or tip another individual for personal benefit.”

The appeals court felt the government failed to prove all of these facts beyond a reasonable doubt.  Consequently, the three judge panel not only reversed the convictions, but they threw out the cases altogether.

In addition, the Second Circuit Court of Appeals attacked the Government’s contention that simply obtaining and trading on material nonpublic information was in itself enough to constitute a crime.

“Although the Government might like the law to be different, nothing in the law requires a symmetry of information in the nation’s securities markets.    The Supreme Court explicitly repudiated this premise not only in Dirks, but in a predecessor case, Chiarella v. United States.    In Chiarella, the Supreme Court rejected this Circuit’s conclusion that ‘the federal securities laws have created a system providing equal access to information necessary for reasoned and intelligent investment decisions . . . . because [material non‐public] information gives certain buyers or sellers an unfair advantage over less informed buyers and sellers.’  445 U.S. at 232.   The Supreme Court emphasized that ‘[t]his reasoning suffers from [a] defect. . . . [because] not every instance of financial unfairness constitutes fraudulent activity under § 10(b).’”

Potential Impact of the Decision

The response to this decision has been extreme from both prosecutors and defense attorneys.  On the one hand, prosecutors feel the appeal court’s decision will make it extremely difficult to prove insider trading cases – particularly when tippees are far removed from tippers as it will be difficult to prove that the tippees knew what benefits the tippers received to provide material nonpublic information.

In a public statement, US attorney Preet Bharara said that the appeal court’s ruling “interprets the securities laws in a way that will limit the ability to prosecute people who trade on leaked inside information.”  Mr. Bharara said he was still evaluating the ruling and was considering appealing it to the Supreme Court.

Defense attorneys, however cheer the clarity that the appeals court provided in its decision regarding what the government must prove to win an insider trading case.

Some also suggest that the appeals court ruling could be extremely good news for other insider trading cases awaiting appeal.  Michael Steinberg, of SAC Capital Advisors was also convicted of insider trading last year, and the judge who provided “erroneous instructions” to the jurors in  Newman’s and Chiasson’s trial was the same who presided over Steinberg’s case — Judge Richard J. Sullivan.  In that case, Steinberg was also far removed from the sources of the material nonpublic information.

The dismissal of the case against Mr. Chiasson and Mr. Newman could also lead to other dismissals — particularly those of cooperating witnesses who pleaded guilty to trading on the same material nonpublic information obtained from Dell and Nvidia insiders.  The reason these reversals might occur is because the appeals court concluded that not only were Mr. Chiasson and Mr. Newman unaware that insiders had received a benefit, but that no such benefit had ever existed. This means that no insider trading took place.

Integrity’s Take

It is important to note that there is no actual legislative statute which specifically addresses insider trading or makes it illegal.  Rather, courts have interpreted the general law against securities fraud and have applied it to prohibit “insider trading”.  Unfortunately, over the years the courts have not made it clear exactly what it takes for a tippee to be found guilty of insider trading.

The appeals court’s reversal of Mr. Chiasson and Mr. Newman’s insider trading convictions are important as this decision makes it clearer when a tippee is liable.  This decision is also likely to have a significant impact on the government’s ability to prove insider trading cases when the purported tippee is not directly connected with the tipper because it will be harder to prove that a tippee knows that the tipper breached his/her fiduciary duty by receiving a benefit to provide this inside information.

In addition, the appeal’s court made it clear that the Government could not rely on the argument sometimes used that a “benefit” is being bestowed merely as a result of the tipper and tippee being friends.  The appeals court clearly highlighted that a fraudulent breach of fiduciary duty could not be proven unless the personal benefit received by the tipper in exchange for the confidential information is of “some consequence”.

Ultimately, we feel that if the appeals court decision stands, prosecutors will be limited in their ability to win insider trading cases unless the tipper and tippee directly interact, or unless the tippee is clearly aware that the tipper breached his/her fiduciary duty by receiving a meaningful benefit, and despite knowing this the tippee still traded on the inside information.

We also see this case as important as it clearly outlines that a tippee IS NOT guilty of insider trading even if he/she obtains material nonpublic information AND ALSO trades on it.  Merely profiting from an informational advantage IS NOT the basis for criminal action.  Instead, a tippee is only guilty of insider trading if he/she provides a substantial benefit to the tipper to encourage him/her to breach their fiduciary duty by providing this inside information to the tippee, and then the tippee trades on this information.

Despite what many people beleive (including numerous regulators and journalists), hedge fund investors can still discover and profit from informational advantages without fear of being charged with a criminal activity.

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