Panic over 'cash for access' clampdown

Investment bankers are renowned for finding new ways to make money. A crackdown by the UK's Financial Services Authority on asset managers using investors' cash to pay bankers and brokers for access to the senior executives of their corporate clients appears to be bringing this innovation to the fore.

The FSA said earlier this month that it had evidence that some asset managers are spending "tens of millions of pounds" a year of clients' money on corporate access.

The regulator reiterated that client commissions could only legitimately be used to pay for trade execution and research. Anything else was strictly against its rules and has been so since 2006. But signs are emerging that at least some of the middlemen that arrange meetings between asset managers and senior executives are seeking to rebrand their services rather than surrender this lucrative income stream.

"At least one broker providing corporate access has reclassified this activity as 'specialist research'," says Alan Miller, founding partner and chief investment officer of SCM Private, a London-based investment manager, and a campaigner for more transparent fees.

Dan Heron, senior associate at Remarqua, a capital markets advisory firm, and a former Gartmore fund manager, adds: "Some investment banks are already addressing the perceived ambiguity by producing 'new' research for corporate roadshows and insisting that the relevant equity analysts now accompany corporate executives", something that did not tend to happen before the FSA's clampdown.

"This, so the argument goes, improves the case for access to be seen as part of the research and decision-making process of fund managers. Therefore corporate access can be 'softed' under existing execution commission agreements.

"It remains to be seen whether this arrangement is acceptable in the eyes of the regulator, although the initial prognosis is that it won't be."

The director of investor relations at a FTSE 100 company, who declined to be named, says fund managers are increasingly using broker research during one-to-one meetings with chief executives, and then talking to the broker again afterwards.

These tactics reflect a view that the divide between corporate access and research may not be clear-cut.

When the FSA first highlighted its concerns about payments for corporate access in November 2012, it said it was merely reiterating a longstanding policy, not instituting a new one.

Yet the Investment Management Association, the industry trade body, said in guidance advising its members on how to the respond to the FSA's concerns that "industry reaction on the both the buyside and the sellside reflects a widely held view that ... there has been a changed and narrower interpretation by the FSA of existing rules".

The IMA added: "Asset managers have many years of supervisory experience in which reviews of the use of dealing commission procedures did not challenge bundled payments which included corporate access."

Yet, since 2007, the FSA's handbook has carried a very detailed definition of what constitutes "research" that can be paid for out of client commissions.

To be compliant, every one of four conditions must apply: a) that it adds value to investment decisions by providing new insights; b) that it represents original thought; c) that it has intellectual rigour; and d) that it involves analysis or manipulation of data to reach meaningful conclusions.

On the face of it, there would seem to be no obvious way corporate access could meet this definition. If a senior executive did provide new insights or original thought, this would presumably constitute non-public inside information, which a fund manager would be barred from acting upon.

However, the IMA, in its guidance, said it "understands some firms will take a conservative view ... such that if a sellside analyst is not present and adding research value in a meeting with company management, payment will not be made through dealing commissions", implying that commission payments may still be made when analysts are present and adding value.

Data from the annual 2012 Thomson Reuters Extel survey, based on responses from 4,200 buyside employees, suggest 27 per cent of client commissions are being used to pay for corporate access.

Perhaps unsurprisingly, this is believed to have caused difficulties for some of the 195 chief executives who have been asked by the FSA to attest that they have no conflicts of interest with their customers in areas such as corporate access.

The chief executives of some of the largest asset managers have been "in a state of close to panic about signing the attestation letter", the head of institutional sales at a major data provider said in a private conversation, according to one source.

The salesman had apparently been approached by several asset managers asking if it was possible to produce a data system detailing the payments each house is making to different brokers and how these sums are determined.

The "Dear CEO" letter, requiring the attestation of compliance, "has lit a fire under the industry and its practices", according to Mr Heron.

The issue also poses questions for investee companies themselves. Asset managers willing and able to make the largest commission payments (or direct cash payments) will tend to get the greatest access to senior executives, even if they are not the most useful managers for a chief executive to meet (particularly likely if they are hedge funds that may go on to short the company).

"Is a company's goal towards a strong, long-term and stable shareholder base best served by passing responsibility for a roadshow to an obviously conflicted corporate broker?" Mr Heron asks rhetorically.

He adds that the UK Corporate Governance Code stipulates that nothing "should be taken to override the general requirements of law to treat shareholders equally in access to information".

His conclusion is that companies will be forced to take responsibility for corporate access in-house. This is the pattern outside the UK where "house" brokers, a peculiarly British phenomenon, do not exist.

However large European companies may employ 10-20 in-house investor relations staff, compared to just one to two in the UK. If so, this could be an area of rapid employment growth.

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