FSA Paper : Conflicts of Interest between Asset Managers and their Customers : Identifying and Mitigating the Risks

3 How firms managed the purchase of research and trade execution services on behalf of customers
3.1 Too few firms adequately controlled spending on research and execution services
Firms regularly spend millions of pounds of their customers’ money buying research and execution services from brokers. Only a few firms we visited exercised the same standards of control over these payments that they exercised over payments made from the firms’ own resources. One firm had carefully considered which services represented valuable inputs to its investment process and challenged brokers about why it should pay for other services. Another firm set a maximum spend on research services and, once these limits were reached, switched commission rates for the brokers concerned to execution-only rates for the remainder of the commission period. These firms could show us that they were both acting in their customers’ best interests and putting customers’ interests before their own.
Poor practice we identified included no central organisation of commission payments where individual fund managers paid for research services by directing business to particular brokers on a trade-by-trade basis. It was unclear to us how firms using this approach monitored whether they were acting in customers’ best interests.
3.3 Firms with strong controls over commission were better able to demonstrate control over the execution of customer orders
Firms with poor controls over how they spend customers’ commission put at risk their ability to execute transactions by directing them to counterparties or venues that might not provide best execution. We found that firms with the strongest controls over commissions also tended to have the best monitoring over execution. Good practice we observed in this area included a designated management committee, using transaction cost analysis to assess and challenge the performance of dealing desks.
FULL PAPER :  Conflicts of Interest.pdf
AUTHORS :  Financial Services Authority
DATE :  November 2012