THE ALLIANCE IN SUPPORT OF INDEPENDENT RESEARCH
c/o Pickard and Djinis LLP
1990 M Street, N.W.
Washington, D.C. 20036
(202) 223-4418 (202) 331-3813
September 20, 2002
Mr. Jonathan G. Katz, Secretary
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
Re: Commission File No. S7-30-02
Dear Mr. Katz:
The Alliance in Support of Independent Research is pleased to have this opportunity to comment on proposed Regulation Analyst Certification ("Regulation AC") which seeks to address the pressures on a research analyst's independence and objectivity brought about by investment banking relationships.
The leading members of the Alliance in Support of Independent Research ("Alliance") include the following broker-dealers:
Boston Institutional Services, Inc.
D. Ward Blodgett, President
Capital Institutional Services, Inc.
Don C. Potts, Chief Executive Officer
Fidelity Investments, Institutional Brokerage Group
Richard W. Collett, Vice President
The Interstate Group,
A Division of Morgan Keegan & Company, Inc.
Grady G. Thomas, Jr., President
Westminster Research Associates, Inc.
A Subsidiary of The Bank of New York
John D. Meserve, President
We believe our members are involved in a significant portion of the arrangements under which fiduciaries such as mutual fund managers, investment advisers, banks and other fiduciaries are provided with independent research services and products for the benefit of their managed accounts.
Members of the Alliance share a common interest in fostering a favorable regulatory environment in which research services and products may be furnished to the money management community, and in preserving the umbrella of protection Section 28(e) of the Securities Exchange Act of 1934 provides to fiduciaries who receive all forms of investment research. A primary goal of the Alliance is to promote observance of proper standards under the securities laws for disseminating research.
As providers of independent research to the institutional investment community, we focus our comments on the aspect of the proposal which imposes certification requirements and recordkeeping obligations on broker-dealers which distribute research reports to fiduciaries and other institutional accounts but do not employ the research analysts who are the authors or originators of such research reports.
We support the efforts of the Commission to address the pressures brought to bear on research analysts' independence and objectivity by virtue of their affiliation with broker-dealers engaged in investment banking activities. However, for the reasons noted below,the Alliance members submit that the scope and applicability of Regulation AC is overly broad in that it would apply unnecessarily to and be an onerous burden on broker-dealer firms which are not subject to the same conflicts which the regulation is designed to address.
Proposed Regulation AC would require that all broker-dealers and associated persons, whether or not they engage in investment banking activities, who publish, circulate or provide, directly or indirectly a research report prepared by a research analyst include a prescribed certification by the analyst in the research report. Additionally, the broker-dealer would be required to make a record each calendar quarter, regarding public appearances by the research analyst, that includes a written statement by the analyst certifying the accuracy of his views and the nature of his compensation. Thus, Regulation AC, as presently cast, would require broker-dealers providing third-party research (e.g., research of an investment adviser or other type entity) to: (1) be responsible for ensuring that these research reports produced by third parties include the required analyst certifica tions; as well as (2) make records including written statements by a research analyst regarding his public appearances, the accuracy of his views and the nature of his compensation.
As noted below, broker-dealers providing third party research reports of outside advisers or independent parties have no control over and are not knowledgeable of the views of the authors of such reports or their compensation arrangements. Further, the imposition of such a requirement on them would not address the conflicts highlighted inthe Commission's Release in respect of the research analyst/investment banking relationship.1 To the contrary, Regulation AC would impede the dissemination of disinterested research to the institutional investment community, the very objective Regulation AC strives to accomplish.
Provision Of Independent Or Third Party Research Under Section 28(e)
Fiduciaries such as investment advisers and portfolio managers commit a portion of their portfolio executions to broker-dealers who are able to offer research that assists in the investment decision-making process. A significant portion of this research provided by broker-dealers to institutional money managers consists of independent and disinterested research (sometimes referred to as "third party research") which is produced or authored by research boutiques and other research originators, who, in turn, operate independent of the broker-dealer providing the research. Third-party research is typically produced by either registered investment advisers or parties who qualify for the "publishers exemption" to investment adviser registration. Registered advisers are already subject to a full panoply of fiduciary and conflict disclosure requirements under the Investment Advisers Act of 1940, or parallel state laws. In order to qualify for the publishersexemption, the advice rendered must be, among other things "disinterested," which means free of the very types of conflicts the proposed rules are designed to address.2
Arrangements for the provision of independent or third-party research for portfolio compensation are frequently referred to as soft dollar arrangements. The foundation for the provision of this research is Section 28(e) which furnishes a safe harbor for the payment of compensation from managed accounts as consideration for the receipt of independent research services by the institutional money manager.
Section 28(e) provides a safe harbor for the provision of independent research to fiduciaries so long as the broker-dealer providing the research and not the fiduciary is obligated for payment to the independent research producers for the research being provided. In almost all instances, the independent research is selected and approved by the institutional money manager, and the money manager almost always receives the research directly from the third-party vendor. Indeed, in order to have the coverage of Section 28(e) a money manager is required to make a good faith determination that the commissions or other forms of compensation paid on portfolio executions are reasonable in relation to the services being rendered by the broker (i.e., the execution and research services). In order to make that determination, the money manager must have knowledge of the research being provided and its value to the investment decision-making process. On the other hand, the providing broker-dealer of independent research under a Section 28(e) arrangement is not in a position to judge the efficacy of the research upon the investment decision-making process undertaken by the institutional money manager. Nor is the providing broker-dealer in a position to ascertain or address the conflicts of interest of the author of the research or the attendant disclosures which might be imposed on the author or the party producing the research.
While it may be appropriate to require that a broker-dealer which issues a research report of a research analyst employed by it to comply with provisions of the type called for by Regulation AC (and such a narrower application of Regulation AC would more specifically address the conflict posed by the research analyst/investment banking relationship), it would be overly inclusive and in some instances an impossible regulatory burden to extend the certification and recordkeeping requirements to distributing broker-dealers who do not employ the research analysts who author the reports.3 The underlying conflict which Regulation AC attempts to address simply does not exist in regard to the provision of third-party research reports by broker-dealers under these circumstances. Ironically, applying Regulation AC across the board would result in a diminution ofindependent or disinterested research services being provided to institutional money managers by broker-dealers.4
Proposed Modification To Regulation AC
In the Commission's Release accompanying proposed Regulation AC, the Commission asks for comment on whether the definition of research analyst should be narrower than proposed. We submit that § 242.501 and § 242.502 should be modified as follows [new language underlined]:
§ 242.501 Research reports.
A broker or dealer, or any person associated with a broker or dealer, that publishes, circulates, or provides, directly or indirectly, a research report prepared by a research analyst employed by such broker or dealer shall include in that research report a clear and prominent certification by the research analyst containing the following statements....
§ 242.502 Public appearances.
(a) If a broker or dealer, or any person associated with a broker or dealer, publishes, circulates, or provides, directly or indirectly, a research report prepared by a research analyst employed by such broker or dealer, the broker or dealer must make a record within thirty days after each calendar quarter in which the research analyst has made a public appearance that includes a certification by the research analyst containing the following statements....
This modification would properly focus Regulation AC on the potential conflicts of interest relating to the research analyst/investment banking relationship and not on those broker-dealers which provide independent research and otherwise have no involvement in the authorship or preparation of the research.5
We hope these comments assist the Commission in formulating a regulation pertaining to research reports which address the concerns noted in the Release. Please call Lee A. Pickard or Mari-Anne Pisarri at 202-223-4418 if you have any questions.
The Alliance In Support Of Independent Research
By: Lee A. Pickard, Esq.
Pickard and Djinis LLP
Counsel to The Alliance
In Support Of Independent Research
cc: (By Hand)
Hon. Harvey L. Pitt
Hon. Paul S. Atkins
Hon. Roel C. Campos
Hon. Cynthia A. Glassman
Hon. Harvey J. Goldschmid
Ms. Annette L. Nazareth
Mr. Paul F. Roye
Mr. James A. Brigagliano
Mr. Thomas D. Eidt
|1|| As the SEC's proposing release for Regulation AC points out, other laws and regulations already address potential conflicts related to research analysts' compensation. See NYSE Rule 472 and NASD Rule 2711, which prohibit tying analysts' compensation to specific investment banking transactions and mandate disclosure of compensation and ownership interests in a company that is the subject of the research report. Further, the anti-fraud provisions of the federal securities laws also require disclosure of compensation arrangements which represent a material conflict of interest for the author of a research report.
|2|| Advisers Act, Section 202(a)(11); Lowe v. Securities and Exchange Commission, 472 U.S. 181 (1985).
|3|| Inasmuch as broker-dealers providing third-party research, including research reports authored by analysts not in their employment, would not have control over these research analysts, the requirement that such broker-dealers track these research analysts and gather written statements from them in instances where they make public appearances would in practice be impossible.
|4|| Broker-dealers now provide literally hundreds of independent research services to money managers to assist in the investment decision-making process. These services include not only investment research and information but fundamental databases, portfolio modeling, and strategy software.
|5|| In its Order approving rules of the NYSE and NASD relating to research analyst conflicts of interest, the SEC stated that the disclosure requirements of such NYSE and NASD rules will not apply to independently produced research such as that distributed pursuant to the provisions of Section 28(e) of the Securities Exchange Act of 1934. See SEC Release No. 34-45908 (May 10, 2002) at footnote 28. Thus, the modifications suggested above would conform Regulation AC's coverage to that of the SRO Rules with respect to independently produced research.