The problem with regulators – if you want to stop crime, employ convicts


While the investment research community was already dying from its own self-inflicted wounds the regulators in the EU have more or less grabbed the back of the head of the investment banks and investors and drowned them in more regulation which will kill them off. Instead of asking the investment managers what they valued, the regulators have now sought to “price” value, something they know little to nothing about.

Had it occurred to regulators that what little value added that remains in the system, it is somewhat counter productive to prevent a broker from putting forward a unique piece of research that the client doesn’t actually know they don’t know but could end up being even more valuable because after all price discovery is what markets are all about? However if the broker can’t promote it, what chance has the investment manager got to discover it? Shouldn’t it be up to the client to decide what they receive? If a broker wants to send free research because that is the value they put to it, isn’t it the same thing as a coffee shop offering free samples in the hopes you may go into the store and buy one? Shouldn’t Starbucks be banned from offering free samples ‘unsolicited’ to innocent pedestrians if brokers can’t peddle free research? The client can filter garbage from their side without regulation. Software is sophisticated.

However isn’t this the rub? Clients and brokers are unique in different ways. That is why they attract different customers who like their risk/reward profiles. Some clients need bigger trading capabilities of which they are willing to pay a bigger price for. Some have no need for research but given the heavy participation by the central banks in distorting free market behavior find the need to concentrate their trading. What might look like blatant favouritism is in actual fact a client’s way of protecting an efficient trading platform. Failure to do so could lead to the disruption of that service which in turn will add unnecessary transaction costs which ends up impacting the clients the regulators are seeking to protect.

Also how can a regulator properly price quality? Quantity and box ticking is a broker forte but clients may find a meeting with a sell side analyst was worth $100,000 not the $1,000 the regulator is trying to standardize. It may have been worth minus $10,000 if the meeting added no value. Qualitative aspects of services are very hard to quantify yet the regulator thinks he or she knows better.

Yes, pretty much everyone gets that front running, illegal insider trading and unscrupulous behavior can’t be tolerated and must be met with the strictest punishment. However telling an investor that he or she can’t consume what they want and how they want it beggars belief. It is regulation gone too far. The regulator needs to stop employing underachieving law graduates who don’t understand markets.

If you want vigilance, employ from within the firms – hire convicted traders who can spot an anomaly in an instant rather than a clueless bureaucrat who acts as if he knows what he doesn’t. Don’t laugh. Investment analyst Harry Markopoulos busted the Bernie Madoff Ponzi scheme 5 years before it blew up. He gave the SEC the most basic detailed reasons even a toddler could understand and after three investigations the SEC still couldn’t work it out. 

The SEC even said after its admonishment the following:

The Office of the Inspector General (OIG) investigation did find, however, that the SEC received more than ample information in the form of detailed and substantive complaints over the years to warrant a thorough and comprehensive examination and/or investigation of Bernard Madoff and BMIS for operating a Ponzi scheme, and that despite three examinations and two investigations being conducted, a thorough and competent investigation or examination was never performed.”

Instead of receiving a stipend from the treasury, regulators should get higher access/user fees from market participants so they can run multi-year budgets properly, hire decent people at market rates and invest in maintaining stable, orderly and functional markets. Market integrity is the game. Slapping on excess and onerous compliance costs stifles activity.

Industry associations are behind paying higher fees. Rick A. Fleming of the SEC’s Investor Advocate said in August 2014, “To some, the idea of a “user fee” sounds a lot like a tax. But several industry associations that represent investment advisers have actually endorsed the concept of user fees. They recognize that a rogue adviser not only harms investors, but also leaves a stain on the advisory industry, so they support an increased regulatory presence and are willing to pay for it. Let me repeat that – they are willing to pay more money to the SEC so that it can conduct more examinations of advisers.”

So to Europe’s new MiFID rules.

European Authorities have published new details on the implementation of Research Unbundling as of Jan 18, 2017.

Unsolicited research can’t be accepted by Investment Managers based in Europe anymore. Providers (Investment banks, brokers, independents) will have to stop sending them research content that is not directly paid for.

“It is not acceptable for firms to receive research for free where no assessment has been made under the above inducements rules or there is no payment arrangement in place that complies with Article 13 of the MiFID II Delegated Directive.”

European Investment Managers have to comply with unbundling regardless of the location of the research providers (investment banks, brokers, independents). If they want to service them, they have to supply and price execution and research services separately.

“EU/EEA firms subject to MiFID II inducements rules must comply with these requirements (Article 24, paragraphs (7), (8) and (9), and the relevant level two provisions) irrespective of the status or geographical location of the research provider”

Sponsored research (commissioned by the issuer) can’t be paid for by investment firms based in Europe. This research needs to be made available to all investment firms at the same time.

If Europe wishes to completely bury the industry, they’re going the right way about it.

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