Improving Your Golf Game and Curing Underperformance

October 20th, 2014

Readers of this blog know full well that the investment research business has been impacted by a number of factors over the past decade which has pressured the active management business.  One of the most obvious issues (though one that is often not discussed) is the consistent underperformance of the investment management industry.  Unfortunately, few ever discuss how buy-side investors might improve their investment performance.  The following article starts an important discussion on this topic.

The Problem

More than 80% of actively managed funds underperform each year, and it has been this way for decades. In response several trillion dollars of capital has been reallocated away from active management and into passive products like index funds and ETFs with no end to this trend in sight. If this weren’t enough, fees for active management are continuing to drop like a rock. All told, the future for active management is very challenging especially if the current dynamics continue.

And that’s where a new book called “Managing Equity Portfolios: A Behavioral Approach to Improving Skills and Investment Processes” by industry veteran Michael Ervolini offers hope to the industry. Recently published by MIT Press, Mike’s book challenges active equity managers to improve their performance before it is too late and then provides practical ideas for how to begin improving their skills using an intuitive but rigorous method he lays out in a straightforward style.

Michael Ervolini has over 27 years of experience in institutional investment management and software development.  Prior to co-founding behavioral finance firm Cabot Research, Mike was a founder and CEO of Charter Research Corporation. Previously Mike was a Portfolio Manager and Chief Information Officer with AEW Capital Management where he first started using information technology as a strategic tool to run institutional portfolios. He was also a Vice President with Legg Mason Real Estate Institutional Advisors (Philadelphia, PA). Mike holds a B.A. in economics from Rutgers University and an M.S. from the University of Pennsylvania.

How To Start Solving The Issue…

The following quotes from Mike’s new book get to the heart of how asset managers might be able to start identifying and practicing the skills they need to improve their performance.

“One reason that so many equity managers can’t improve is poor feedback. Here is what I mean. Traditional portfolio analytics like relative return, information ratios, alpha hit rates and attribution are useful to a point  … but what they all share in common is that they are merely scorecards.  They measure how the manager did over a period of time and that’s it. They say nothing directly about skill and that is a huge problem. It is as if a golfer is only told the scores of her games and had no idea of where she had the most skill: Is it her drives off the tee? Her irons in the fairway? Or her putts? Armed with only the scores she would have no chance of becoming self aware or improving. This is precisely the bind that equity managers are in today. It’s why they can’t improve.”

Mr. Ervolini continues his explanation, “For example, all managers should know whether they generate more excess return from their buying or their selling. But they don’t. They have a gut feel or an intuition but they really don’t know. And not knowing your personal strengths and shortcomings makes it impossible to improve. I have this very conversation regularly with managers around the globe and they all agree that they would like to improve but they are not sure of which of their skills are strongest and which need retooling.”

Mike expands on his golfing analogy, saying “Unlike portfolio managers, golfers benefit from rigorous and granular feedback about their skills and sub-skills. It is the quality of the feedback that enables them to improve even when they are at the pinnacle of their ability. My book provides a new analytic framework that enables equity managers and analysts to get on par with golfers when it comes to feedback. Each page contains practical information for becoming more self aware and a better investor. The book describes a new analytic framework that enables professional investors to quantify how much skill they have at buying, selling and sizing positions. The book also shows how to use this information to improve deliberately. Hundreds of managers and analysts are using these techniques today and they are seeing terrific results. Put simply, if you want to survive as an equity manager you need to do better and my book offers you the roadmap to stronger skills, investment processes and eliminating behavioral tendencies.”

Two Key Findings

The following summarizes a few of the key findings of the research that Mr. Ervolini lays out in his new book.   “I’ll end on this note. At Cabot we’ve analyzed hundreds of professionally managed equity portfolios and here are just two of our findings. First, virtually all managers, even those that have been above their benchmarks for years, have at least one skill that is negative and it is draining performance from the portfolio. Second, over eighty-five percent of managers exhibit at least one behavioral tendency that is very persistent and costs the portfolio in excess of 100 bps of return year-after-year. The question then is: What behaviors are hurting your performance and isn’t it time to find out?”

Mike’s book and the need to help active management are the topics of an event being hosted by Bloomberg LP on Tuesday, November 11, 2014 starting at 4:00 PM, in NYC. Contact if you’d like to attend this industry-wide conversation about the future of the asset management business.  You can learn more about Mike’s new book, and purchase it directly by clicking on the following link

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Conference on Broker Voting

October 17th, 2014

The Wall Street Transcript (TWST), the venerable publication of CEO and analyst interviews, will be hosting a Broker Vote Summit on October 22nd at The Harvard Club in New York City.  The conference is well timed in light of regulatory pressure to increase transparency on research pricing and valuation.  Readers of our blog are being offered a 15% discount on the registration fee.

The  conference is being organized by TWST Events and features the Wall Street Transcript’s subsidiary MeetMax, which offers software to facilitate conferences and road shows.  MeetMax also has a broker vote service.

The Broker Vote Summit will include buy side and sell side panels, as well as 1:1 meetings (using MeetMax’s conference software, naturally) and vendor workshops.  Vendors of broker vote solutions, including Markit, Extel and State Street Global Markets as well as the host firm, will be in attendance.  The key note speaker is David Maber, a professor at the University of Michigan who has authored a study on broker voting.  The conference agenda can be found at

Increasing regulatory scrutiny in the UK and Europe of research payments and pricing is bringing broker voting into the spotlight.  Broker voting helps to increase transparency, and will most likely evolve further as a result of regulatory reform.

Readers of our blog are being offered a 15% discount on the $495 registration fee.   To register for the conference go to

To obtain the 15% discount, submit the code “INTEGRITY” (all caps) when asked for a discount coupon.

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New Research Distribution Platform Launched

October 15th, 2014

A new Edinburgh-based research distribution platform is seeking to create a marketplace where research can be sold and purchased transparently.  The new platform, Electronic Research Interchange (ERIC), was launched earlier this month and is said have fund managers from over 100 asset managers worldwide registered on the site.

“We have in the region of 25 research providers already posting research items on the site, ranging from one man independents to full service brokers, with many more in the pipeline,” said ERIC co-founder Chris Turnbull.  One of the research providers is co-founder Russell Napier, a former CLSA strategist whose global macro analysis will be exclusively distributed on the platform.  Napier will also provide a free fortnightly Global Macro update for registered users of ERIC.

Each research provider effectively has their own ‘micro-site’ on the platform and fund managers are permissioned by the research provider once they have agreed to terms and conditions.  Similar to eBay, ERIC gives research providers the ability to set a ‘Buy It Now’ price and to give fund managers the opportunity to ‘Make an Offer’ for research.  ERIC also facilitates auctions for scarce resources such as analyst access or meetings.

Co-founder Chris Turnbull was previously an Investment Director at Standard Life Investments and has worked latterly at Instinet and at ICAP BlockCross.  Russell Napier was a strategist with CLSA Asia-Pacific Markets for almost twenty years and was previously a fund manager at Foreign & Colonial and Baillie Gifford.  ERIC’s anonymous third investor donated his holding to a charity allowing him to retain an interest without gaining any financial benefit, therefore removing any conflict with his senior role at an Edinburgh-based asset manager.

The full press release is below:

1st October 2014

ERIC — the home of unbundled research opens for business with exclusive free content from Russell Napier

Russell Napier and Chris Turnbull, the co-founders of ERIC (Electronic Research Interchange —, today launch a new option in the procurement of substantive investment research and analyst access to investment professionals. In response to growing demand from professional investors for the menu pricing of research, ERIC provides access to thousands of pieces of individually priced research from leading providers.

According to co-founder Chris Turnbull, Former ICAP broker and previously an Investment Director at Standard Life Investments, ‘ERIC offers research from an impressive roster of providers from small Independent Research Providers (IRPs) and brokers alike, who realise that professional investors are changing how they spend their research budgets… this business is not about how fund managers access research, it’s more about how they find it, value it and pay for it.’

Subscribers to ERIC will gain access to a free fortnightly market commentary by Russell Napier, formerly of CLSA, author of Anatomy of The Bear and director of The Practical History of Financial Markets graduate course. Napier’s quarterly research report ‘The Solid Ground’, which has been analysing global macro trends for almost twenty years, will be sold EXCLUSIVELY through ERIC.

‘The industry needs a platform where sellers and buyers of individually priced research can transact. ERIC is such a platform and I am delighted to be involved in ERIC at a time of so much change in the financial services industry.’- Russell Napier

Chris Turnbull echoes this confidence in presenting the right product at the right time, ‘THE FCA is asking professional investors to look closely at how they consume and pay for research and ERIC offers the solution, allowing them to source research on an at-need basis.  Full transparency on research consumption and spending through ERIC can then be offered back to the end client.’

The platform has already drawn support from a number of investment managers, both large and small, who see value in widening their research procurement options in an uncomplicated way. In the words of Russell Napier, ‘I hope that many institutional investors will register to access my free fortnightly market commentary and in the process see the high quality research that ERIC has to offer before making it their first stop for unbundled research needs.’

The company logo is Eric the knight, a piece from a Viking chessboard carved almost a thousand years ago and discovered, with his friends, on a beach in Lewis in the Outer Hebrides.  Like the knight in chess, ERIC aims to use its unique ability to jump ahead over other pieces and, as the Vikings did, ERIC comes to change things but ultimately to settle a new land. Our Eric, now sporting a dapper bowler, has been updated to give him that twenty first century Viking look. ‘They’re back but this time with sensible hats,’ commented Russell Napier.

ERIC is an independent business owned by Russell Napier, Chris Turnbull and a Scottish charity- The Creich Charitable Trust.  Russell Napier is proud of the association and confident of the benefits that lie ahead, ‘Creich is a major shareholder in the business and we hope will profit from its holding and thus be able to continue its work supporting many charitable ventures in Scotland and well beyond.’

Click here to view ERIC-LAUNCH

For more information please contact:

Chris Turnbull 07887717423

Russell Napier 07775920134

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Wall Street Layoffs Continue to Shrink While Hiring Stalls in September

October 13th, 2014

Layoffs at Wall Street investment banks and brokerage firms fell in September to the lowest level seen in more than one year, according to a recent private jobs report.  However, the September layoff data doesn’t reflect a strengthening Wall Street employment outlook as new hiring during the month also remained extremely weak due to low market volatility, anemic trading volumes, and pending regulatory changes.

September Challenger, Gray & Christmas Report

According to the Challenger, Gray & Christmas monthly Job Cuts Report released recently, the financial services industry experienced a 39% drop in planned layoffs in the past month from 974 layoffs announced in August to 591 layoffs announced in September.  The decline in planned layoffs in September was also 91% lower than the number of layoffs announced in September 2013.

On a year-to-date basis, Wall Street firms have announced 24,623 layoffs during the first three quarters of 2014, 50% less than the 48,874 layoffs announced during the same period in 2013.  The decline in announced layoffs is a clear signal that the employment outlook is improving modestly.

However, we don’t see this data as evidence that the Wall Street employment picture has become robust.  Financial services firms failed to announce any new hiring during September from a feeble total of 500 new positions announced in August.  This drop in planned hiring is consistent with year-to-date hiring plans at Wall Street firms which are 29% lower so far in 2014 when compared to the same period in 2013.

Fragile Market Conditions Continue

Despite the drop in announced layoffs in September, we expect Wall Street firms will continue to shed workers in the coming months.  Last month, two top trading executives at Bank America Corp., David Moore and David Hartney, left the bank as rumors suggest the firm is preparing to shed positions in the fixed-income and equities divisions on a worldwide basis.

Bank of America is not the lone Wall Street firm making such plans as record low market volatility, weak trading volumes, and concerns over pending regulations contributed to the worst first half in trading since the financial crisis.  In fact, JPMorgan Chase’s CFO Marianne Lake, recently argued at an investor presentation that low volatility and weak customer demand might continue to be the market norm through at least mid-2015.

Britain’s Lloyd’s Bank, is expected to imminently announce the elimination of thousands of jobs in what may be the biggest round of cuts since 2011, a person familiar with the matter said.  The bank will shut branches as part of efforts to automate its entire business, with job cuts expected in areas such as mortgage processing and new account opening.

Barclays PLC is also expected to announce significant job cuts in the coming weeks.  A person with knowledge of the matter suggests that the bank plans to cut 3,800 jobs in 2014 at its consumer and business banking division.  Close to 1,300 positions have already been eliminated in this division, the person acknowledged.

Impact for the Research Industry

In our view, sluggish equity commission revenue cannot bode well for a pickup in research industry hiring.  Combine this factor with the uncertainty caused by recent FCA and ESMA pronouncements about a possible ban in using client commissions to pay for research leads us to believe that very few investment banks or independent research firms (particularly those with significant European business) will ramp up hiring in their research departments until business conditions markedly improve.

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A “Common Application” For Compliance: Can 250 Research Providers Be Wrong?

October 8th, 2014

We are launching a new service designed to make the compliance due diligence process easier and faster for research providers and their asset management clients.  The new service, called Compliance Telescope, already has over 250 brokers and independent research providers distributing compliance information to clients.

The central concept behind the new service is similar to the common application used by college-bound students to apply to schools.  We’ve developed a common questionnaire that consolidates all the redundant compliance questions posed by asset managers to their research providers into one consistent form that brokers and IRPs can fill out once and send out multiple times.

Asset managers like the approach because it saves them time and effort chasing their external research providers for responses.  Also, they are finding that the data is more timely and accurate because it is being used across multiple clients.

We are very fortunate to have teamed up with Castine Consulting, the developer of the new cloud-based service.  Castine was founded by Robin Hodgkins who originated Cogent Consulting, a market leading commission management solution whose products were sold to BNY Convergex.   Robin is a successful serial entrepreneur, and he and his team have come up with a very elegant web-based solution.

We are getting good feedback from the research firms using the platform because it is much easier to complete than excel-based questionnaires many clients use.   The questionnaire remembers previous responses, making the information easier to keep up-to-date.  The platform has robust permissioning, ensuring that the information only goes to clients and prospects approved by the research firm.

Like the common application used by colleges, asset managers can add their own proprietary questions which are unique to them.   Typically these custom questions relate to services provided to that particular client.

A major benefit for both research firms and their clients is a faster onboarding process using the new service.  Many asset managers require compliance information as a condition for adding a new research provider, and Compliance Telescope’s universal questionnaire can shorten the handoffs significantly, making the PMs/analysts on the buy side happy and helping research firms get paid more quickly.

There is no cost for research providers to use the system and asset managers can access the due diligence responses at no cost.  Additional features for asset managers such as custom questions, approval workflow, surveillance alerts, and internal notifications of vendor status require a license fee.

To learn more about the new service, go to

If you’d like to try out the new service contact Tom Smith,, 347-4-CASTINE.

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SEC Charges Two Ex-Wells Fargo Staff with Insider Trading

October 6th, 2014

Last week, U.S. regulators charged a former Wells Fargo equity analyst and a trader with insider trading, saying the analyst tipped the trader about upcoming ratings changes for six healthcare stocks.

Background of Case

The Securities and Exchange Commission alleges that between April 2010 and March 2011, former Wells Fargo healthcare analyst, Gregory Bolan Jr., tipped ex-Wells Fargo trader, Joseph Ruggieri, about research ratings changes he was about to release on eight healthcare stocks.  The SEC charges that Ruggieri traded on six of these tips, reaping $117,000 in profits.

The SEC said that Bolan also tipped another friend about these ratings changes, enabling him to earn $10,000 in profits.  This friend has since died.

The stock tips that Ruggieri purportedly traded on were about Albany Molecular Research Inc., AthenaHealth Inc., Bruker Corp., Covance Inc., Emdeon Inc. (now part of Blackstone), and Parexel International Corp.

Sanjay Wadhwa, Senior Associate Director of the SEC’s New York Regional Office explained the charges, “Instead of abiding by firm policies that specifically prohibited trading ahead of published research, Ruggieri used information obtained from Bolan to make profitable trades in advance of six separate research reports.  The repeated nature of these violations demonstrates an utter disregard for our insider trading laws.”

The SEC says that Bolan is now working for Sterne Agee Group in Nashville, Tennessee, while Ruggieri is employed by ISI Group out of Raleigh, North Carolina.

Wells Fargo itself was not charged in this case as the bank purportedly provided compliance training to both its research analysts and its traders that this type of pre-release communication was strictly prohibited.

The case is being brought in the SEC’s administrative court (administrative proceeding number 3-16178).  The administrative proceeding will determine what, if any penalties and relief will be sought against Bolan and Ruggieri, including disgorgement of ill-gotten gains, prejudgment interest, financial penalties and other remedial measures.

Challenge to SEC Case

Sam Lieberman, of Sadis & Goldberg LLP, the defendants’ lawyer said Bolan and Ruggieri “vehemently deny” the charges and that the SEC’s decision to bring the case as an administrative proceeding instead of in federal court raises questions about its case.

Lieberman explained “Mr. Ruggieri did not receive a profit of $117,000 from the alleged trading … the trades took place in a Wells Fargo proprietary account in which he only received 6 percent of profits. That is just the tip of the iceberg regarding the defects in the SEC’s case.”

Integrity’s Take on the Case

It is clear to us that Bolan’s alleged tipping Ruggieri about pending research ratings changes probably broke Wells Fargo’s own compliance polices about this type of communication (the reason Wells Fargo provided compliance training to their staff on this topic).  However, this type of early dissemination of research ratings has unfortunately been going on on Wall Street for some time.

This case has some similarities to the 2012 New York Times story where Lehman Brothers analyst Ted Parmigiani, recounted an instance where he disclosed to other Lehman employees via an internal “squawk box” that he planned to publish a market-moving report on the shares of Amkor Technology within the hour.  However, by the time his report was published the stock had already moved, purportedly because Lehman employees had leaked the news to their clients.  The SEC investigated the case, but never brought charges.

Another relevant case was the Goldman Sachs “trading huddle case”.  The SEC stated that between January 2007 and August 2009 there were hundreds of instances when a ratings change occurred within five business days after the stock was discussed at a “trading huddle” or referenced in huddle-related documents.  The SEC cited specific instances when publishing analysts recommended stocks during huddles after having drafted reports upgrading the stock from Neutral to Buy, or after having proposed downgrades to stocks to research management.  In April 2012, Goldman eventually paid a $22 mln fine to settle this matter of selective dissemination.

However, the key issue in the Bolan / Ruggieri case is whether this could be deemed to be insider trading.  Traditionally, in order for a case to be considered insider trading, the person disclosing the non-public information, known as the tipper, must do so in violation of a fiduciary duty.  In other words, someone who receives material nonpublic information could trade on it unless the person who provided them the information had a fiduciary duty to keep it confidential.  Historically, the Supreme Court has explained that proof that a fiduciary duty was breached is “whether the insider personally will benefit, directly or indirectly, from his disclosure”.

Bolan, a Wells Fargo research analyst who clearly was not an insider (at least in the traditional sense) and who lacked any fiduciary duty to keep his research information confidential, allegedly provided that information to Ruggieri, a Wells Fargo trader, who then used that information to enrich Wells Fargo’s account and ultimately, himself.  The issue that the SEC will need to prove in this case is whether Bolan received any special benefit from Ruggieri or the other unnamed recipient of his tips, to entice him to release the pending ratings changes to them early.

In our minds, the mere fact that the SEC is trying to bring this case against Bolan and Ruggieri as “insider trading” is interesting as it makes us wonder whether the SEC is using this as a trial balloon to see how their arguments are received by the administrative court.  If the administrative court sides with the SEC, we would not be surprised to see them bring other similar cases against clients or bank employees who benefited from the receipt of “material non-public research information”.

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Correction: AlphaSights Now the Top London Expert Network

October 1st, 2014

In discussing the growth of London-based expert networks last week, we erroneously stated that AlphaSights Ltd. was smaller than its rival Cognolink Ltd.  In filings released earlier today, AlphaSights revealed that it doubled its revenues from 2012 to 2013 and its 2013 revenues were 35% larger than those of Cognolink.

AlphaSights grew its revenues from £9.3 million (US$14.9 million) in 2012 to £18.8 million (US$30.1 million) in 2013, a growth rate of 102%.  The firm is solidly profitable and is paying large dividends to its owners.  Employee headcount grew from 63 in 2012 to 108 in 2013, and the firm is still hiring like mad.

AlphaSights is organized differently than most expert networks, which have distinct roles between research managers who service client requests and salespeople bringing in new accounts.  AlphaSights has few if any dedicated salespeople.  Instead, the firm incentivises its research managers to grow business.  The model is clearly working for them.

Critics question whether incenting research managers for growth increases compliance risks.  With a small (but growing) US footprint, AlphaSights did not suffer the intense compliance pushback experienced by its more established US-based rivals in 2010 and 2011.

Today’s filings were the first public disclosures of AlphaSight’s profit and loss.  Under UK rules, companies are exempted from disclosure if they meet two of the following three tests: 1) Annual turnover must be £6.5 million or less; 2) The balance sheet total must be £3.26 million or less; 3) The average number of employees must be 50 or fewer.  Given that AlphaSight’s 2012 revenues were well north of the £6.5 million test and 2012 employees exceeded the 50 threshold, it is not clear on what basis it claimed exemption in 2012.

For 2014, the AlphaSights directors “believe that there is considerable opportunity for the continued development in the activities of the group.”  Understated, but highly credible.

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If MiFID II Stops Short of a Ban, What Can We Expect?

September 29th, 2014

European reforms to equity commissions are creating turmoil for both producers and consumers of equity research.   Although an outright ban on research commissions is looking less likely, the regulators are signaling their intent to pressure for more commission transparency.

To ban or not to ban

If the current MiFID II language stands, there will be ban on using client commissions to pay for any research of value.  The UK Financial Conduct Authority (FCA) publicly supports a ban on research commissions (and is rumored to have drafted the MiFID language imposing a ban.)

However, opposition to a ban is widespread, and regulators are taking note.  Also, we understand from reliable sources that French and German regulators are uncomfortable with a ban, and they have the power to outvote the UK on the final language.  

Movement toward a compromise

Lobbyists who are speaking with the regulators sense that they are looking for a compromise position that enhances commission transparency but stops short of a ban. The FCA is rumored to be reaching out through the International Organization of Securities Commissions (IOSCO) to enlist the US Securities and Exchange Commission (SEC) and Asian regulators to reform research commissions.

While the SEC cannot ban research commissions without an act of Congress, it has broad scope in how it chooses to regulate commissions.  The FCA can’t persuade the SEC to ban research commission, but it might be able to gain agreement on a compromise position.

Will the ban threat just disappear?

So what might be a compromise position?  One possibility is that the offending MiFID II language is simply deleted, as an influential advisory group has recommended.

There is much pushback, even from trade groups representing independent research providers, on whether research should be considered an “inducement”, as framed in the draft MiFID II language. However, the UK regulators have framed all their regulation of commissions, including the latest rules, in the context of regulating inducements.  [See the FCA’s Conduct of Business Sourcebook (COBS) section 11.6.]   The UK provides ample precedent for MiFID II regulation of research commissions under the rubric of inducements.

More transparency

More likely, the European regulators will move closer to the FCA’s current commission regulation, which imposes more transparency while stopping short of a ban.  This is exactly what happened in 2006 with MiFID I.  The UK regulators had just tightened their rules for “eligible research” (now tightened further) and imposed a commission transparency regime.  Although MiFID had no analogous language, MiFID’s “best execution” requirements were construed to support the use of Commission Sharing Agreements (CSAs) to reduce the number of trading counterparties and apportion commission payments to research.

In its most recent rules which took effect in June, the FCA: 1) banned the payment for corporate access with client commissions, 2) required asset managers to place a value on bundled research from investment banks; and 3) prohibited commission payment for research which is not used.

The FCA made it clear that it is looking for asset managers to set explicit budgets for research, so that research payments do not fluctuate with commission volumes.  Woe to the asset manager whose research payments go up just because trading increases.

A boost for CSAs?

One area for compromise might be Commission Sharing Agreements (CSAs) which separate bundled commission rates into execution and research components.  By themselves, CSAs do not do what the FCA is now demanding.  They do not impose budgets on research nor do they place a value on the research received.  However, it would be extremely difficult if not impossible to budget research without them.  In other words, they are a necessary but not sufficient condition for conforming to the new FCA guidelines.

While CSAs have been adopted by many asset managers, a large portion of equity commissions still go through bundled commissions.  In the UK, perhaps 40-50% of commission volumes flow through CSAs.  In the US, according to a survey we conducted earlier this year, 35-40% of equity commissions go through CSAs.  This is a sure sign to regulators that the industry is not wholly on board with greater transparency.

It would not be surprising then if MiFID II ended up supporting greater use of CSAs.  Whether or not CSAs are explicitly mandated, regulators are likely to use CSAs as a metric for measuring industry compliance with greater transparency.

Across the Pond

The industry has taken great comfort from the fact that a ban on research commissions in the US would take an act of Congress.  Plus the SEC seems to have little interest or appetite for the topic of commission transparency.

However, the SEC doesn’t have to stir itself too much to make an impact on commission transparency in the U.S.  In 2010 it issued a no-action letter saying that investment banks could accept commission payments through a CSA (or a Client Commission Arrangement as they are called in the US) without impairing their ability conduct principal transactions.  Nevertheless, investment banks continue to balk at taking payments for their own proprietary research through CSAs.  It would not take much effort on the SEC’s part to correct this.


At this point the future regulatory landscape is still uncertain, but there is no mistaking the direction regulators are headed and the seriousness of their intent.  While an outright ban on paying for research with client commissions is looking increasingly unlikely, European regulators seem disposed to use MiFID II to prod the industry for more commission transparency.  CSAs are well positioned to benefit.

We suspect that European regulators will go even further toward replicating the current FCA rules, whether or not explicit language is incorporated in the MiFID II rules.  European regulators may not have the FCA’s detailed understanding of research commissions, but they can grasp the concept that research payments should not increase just because trading volumes increase.  It is even possible that the SEC might make a token effort in the interest of regulatory harmony.

While the industry might breathe a sigh of relief at averting a ban on research commissions, the prospect of broad regulatory acceptance of the new FCA regime will be more than sufficient to ensure major changes in the research landscape.  More on that later.

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London Expert Networks Challenging US Rivals

September 24th, 2014

London-based expert networks Cognolink and AlphaSights have been growing quickly, benefiting from a diverse client mix, geographic expansion, and limited impact from insider trading investigations.  Both firms are now proactively expanding their business, challenging US-based expert networks on their own turf.

Cognolink Ltd. is a London-based expert network founded in 2007 by Emmanuel Tahar, an ex-Bain consultant.  From the beginning, the firm has focused on a diverse client base, targeting management consultants and private equity along with hedge funds.  It also prioritized geographic expansion, establishing a US subsidiary in 2010, a Shanghai-based subsidiary in 2011, and subsidiaries in Hong Kong and India in 2012.

These strategies were rewarded in 2013 when the firm grew nearly 60%, from £8.7 million (US$14 million) to £13.9 million (US$22 million).  The firm is well established in the UK, where its business grew 74% in 2013 and is growing rapidly in the US and Asia (80%) albeit from a small base. Cognolink forecasts strong growth in 2014 “with profitability and cash inflows”.

Cognolink booked $6.7 million in revenues in the US in 2013, which represented almost a third of the company’s revenues, although it still has captured only a small portion of the overall US spend on expert networks.

AlphaSights Ltd. was founded in 2008 by two German entrepreneurs and, although not as large as Cognolink, has also been expanding geographically.  In addition to its London home office, it has offices in New York, Hong Kong and Dubai.

AlphaSights recently moved to new space in NY, promoting a hi-tech inspired atmosphere, not too far from Gerson Lehrman Group’s swank new offices near Grand Central.

AlphaSight’s New York Office

Neither Cognolink nor AlphaSights can rival GLG’s size or global footprint.  GLG’s revenues have once again topped $300 million, regaining past glory after declines triggered by insider trading prosecutions.  The London-based expert networks were largely immune from those pressures.  Now, having established solid bases in London, they are expanding outward.  Although dwarfed by GLG’s scale, they are aggressive competitors to all the US-based expert networks.

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Hedge Fund Caught Using Soft Dollars To Pay Twice For Fake Research

September 22nd, 2014

Earlier this month, the SEC charged a Minneapolis-based hedge fund with running a scam that diverted more than $1.0 million in “fake research” fees and expenses to illegally pay for staff salaries, country club dues, boarding school tuition and a Lexus.

Charging Investors Twice for Fake Research

A few weeks ago, the Securities and Exchange Commission charged that between 2008 and 2013, Minneapolis-based hedge fund Archer Advisors LLC, owner Steven R. Markusen, and employee Jay C. Cope bilked investors out of more than $1.0 million in phony research expenses and fees as the hedge fund’s deteriorating performance led to shrinking fund income.

According to the SEC’s complaint, Markusen and Cope’s scam actually charged fund investors twice for fake investment research expenses.  First, Markusen billed the funds directly for what he claimed were Archer’s out-of-pocket research expenses.

Markusen caused investors to repay Archer almost $500,000 in fake research expenses.  Of this total, Markusen directed the funds to reimburse Archer $100,000 for Cope’s salary payments by falsely characterizing them as “’research” expenses. The SEC alleges that Markusen spent these proceeds on personal luxury items like boarding school tuition, country club dues, and a Lexus.

However, this was not enough for Markusen and Cope.  Purportedly, Markusen also generated fake research invoices to direct Archer’s brokers to pay Cope’s $10,000 per month salary out of soft dollars for “research” he allegedly did as an independent consultant.  However, Cope did little or no research for Archer.  He was an Archer insider and officer whose main duties were helping Markusen find new investors and placing trades.  In total, Archer directed it’s brokers to pay Cope $450,000 in illicit “soft dollar” payments directly out of client assets rather than out of fee income earned from managing investor assets.  Cope paid Markusen a $1,000 monthly kickback from these soft dollar payments.

The SEC explained its charge against Markusen and Cope, “Soft dollars were supposed to be used to buy third-party investment research that benefited the funds.  Cope conducted no third-party research as an Archer officer whose main duties were placing trades and helping Markusen find new investors.”

In order to generate sufficient soft dollar commissions to pay for Cope’s salary, the SEC contends that Markusen and Cope began to aggressively trade their fund, prompting commissions paid to the funds to jump more than 600% from approximately $5,200 in March 2013 to almost $36,000 in April 2013.

Portfolio Pumping Scheme

The SEC’s complaint also charges Markusen and Cope with conducting a separate scheme to manipulate the stock price of the funds’ largest holding in order to inflate the monthly returns reported to investors and conceal the true extent of the funds’ mounting investment losses.

According to the SEC, Markusen and Cope manipulated the price of the thinly-traded stock of CyberOptics Corp. (CYBE), which comprised over 75% of the funds’ portfolios.  Markusen and Cope, knowing that Archer was CYBE’s largest shareholder, used this position to materially impact the closing price of CYBE on the last trading day of the month.

Marusen and Cope accomplished this by placing multiple buy orders for CYBE seconds before the market closed on the last trading day of the month to artificially pump up the market value of CYBE, and therefore the overall value of the funds’ portfolios.  Those valuations were used to calculate the funds’ monthly returns that Archer reported to investors, and were used to calculate Archer’s monthly management fee.  The SEC alleges that this illicit “painting the tape” happened in at least 28 months between 2010 and 2013.

“Markusen and his firm had an obligation to manage investor money in the hedge funds fairly and honestly.  Instead, he and Cope exploited their control of the funds to engage in long-running schemes to misappropriate fund assets and artificially pump up the value of the poorly-performing funds,” says Robert J. Burson, associate director of the SEC’s Chicago Regional Office.

Integrity’s Take

Obviously, the SEC charges against hedge fund Archer Advisors, Steven Markusen, and Jay Cope, if true is an egregious example of a criminal scheme to enrich themselves at the expense of investors in the funds.  However, this case is also an unfortunate illustration of why “soft dollars” has gotten such a bad name among regulators, politicians, and journalists.  The rampant misuse of client assets in this case provides opponents of “soft dollars” an easy illustration of why they believe the use of client commissions to pay for investment research should be banned in order to protect investors from this type of illicit behavior.   It is truly sad how a few bad apples can spoil the whole bunch.

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