September 23, 2002
Via Electronic Mail
Jonathan G. Katz, Secretary
RE: Regulation Analyst Certification, Release Nos. 33-8119; 34-46301; File No. S7-30-02
Dear Mr. Katz:
The Investment Counsel Association of America1 welcomes this opportunity to share our views on proposed Regulation Analyst Certification (Regulation AC). ICAA members collectively manage trillions of dollars in assets for institutional and individual investors. We strongly support measures to promote the integrity and transparency of information that is provided to the public regarding issuers. The ICAA applauds the Commission's efforts to address documented abuses involving certain sell-side research analysts. We comment only to request the Commission to revise the proposed rule explicitly to exclude investment advisers.
The purpose of Regulation AC is to "promote the integrity of research reports and investor confidence in the recommendations contained in those reports."2 Regulation AC principally is intended to address conflicts of interest that arise when a broker-dealer that is also an underwriter or market maker produces its own research. As proposed, Regulation AC would require any research report disseminated by a broker-dealer or "any person associated with a broker-dealer" to include certifications by the research analyst who prepared the report that the views expressed accurately reflect the analyst's personal views and to indicate whether the analyst received compensation in connection with the specific recommendations or views expressed in the report. Broker-dealers or associated persons who publish, circulate, or provide a research report also must make a record that includes the analyst's certification regarding the views expressed in any public appearance during the previous calendar year.
Although proposed Regulation AC is intended to apply to sell-side analysts, investment advisers affiliated with broker-dealers may be covered by the rule as a "person associated with a broker-dealer."3 In addition, under certain circumstances, an investment adviser may be deemed a research analyst, which is defined as "any natural person who is responsible for the analysis of any security or issuer included in a research report."4 The term "natural person" could be construed to include any person who prepares a research report that is circulated by a broker-dealer, regardless of such person's affiliation with a broker-dealer or the purpose of the research report.
It would not be logical - nor does it appear to be the Commission's intention - to include some investment advisers in a rule designed to address concerns related to broker-dealers. Indeed, the Commission cites with approval the NASD's statement that "research analyst" would not include "investment advisers, including fund portfolio managers, who are not principally responsible for preparing the substance of a research report even if they are registered persons of members."5 Accordingly, Regulation AC should explicitly exclude investment advisers from its scope, as discussed below.
The Commission's proposal specifically requests comment on whether the rule should explicitly exclude investment advisers.6 The ICAA strongly urges the Commission explicitly to exclude investment advisers from Regulation AC. Buy-side analysts do not face the types of conflicts or engage in the types of practices that gave rise to this regulation. Further, no record of abuse has been demonstrated to justify inclusion of any segment of investment advisers.
The most significant conflict faced by sell-side analysts relates to their involvement in the investment banking business. The proposal explains: "Sell-side analysts typically work for full-service broker-dealers that sell securities to the public and make recommendations on the securities they cover. Many of the more popular sell-side analysts work for prominent brokerage firms that also provide investment banking services for corporate clients-including companies whose securities the analysts cover."7
Analysts employed by entities with investment banking business have an incentive to issue positive recommendations with respect to companies that are clients because compensation frequently is based on investment banking profits and/or determined with input from the banking division. Further, positive recommendations may be seen as fostering better relationships between investment bankers and issuers.8 In contrast, buy-side firms generally do not have an investment banking relationship with the companies that they study or in which they invest. Buy-side analysts have no internal incentive to make statements that are contrary to the analysis they have performed.
Buy-side analysts typically work for institutional money managers, including advisers to mutual funds and hedge funds. Investment advisers derive their revenues from fees paid by advisory clients based on a percentage of assets under management. They research companies as part of the investment decision-making process for their client portfolios on a discretionary basis. For buy-side analysts, success or failure is a direct function of the accuracy and value-added nature of their analysis. Buy-side analysts are successful if their investment decisions result in good performance for their clients' accounts, leading to growth in assets under management. Their interests are directly aligned with their clients' interests.9
Further, investment advisers operate under a legal framework that requires advisers to mitigate or eliminate conflicts of interest or, in the alternative, to disclose them.10 Investment advisers have a fiduciary duty to act solely in the best interests of their clients and to act with the utmost duty of faith and loyalty.11 Broker-dealers do not have such an explicit fiduciary duty in relation to their customers. An adviser's affiliation with a broker-dealer does not relieve the adviser from its fiduciary obligations and therefore, application of Regulation AC to investment advisers affiliated with broker-dealers would not offer any additional investor protection.12
We welcome the opportunity to discuss this subject in greater detail with the Commission or its staff. Please do not hesitate to contact me if you have any questions about our views on these important issues.
David G. Tittsworth
cc: The Honorable Harvey L. Pitt