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February 1, 2003

The Buyside on Trial?

By John A. Byrne Editor

The buyside is the next target for lawmakers. Three years into a punishing bear market, law makers are told heartbreaking stories from constituents. There are some self-inflicted wounds but these are sad stories. The constituents are ordinary investors, washed up in the wreck, wealth drained away and sucked dry. It is one of those issues that could get uglier once the politicians in DC take a closer look. So far research practices were investigated. IPO practices were scrutinized. Investment banking relationships were examined. The next chapter? Michael Oxley (R-Ohio), the House Financial Services Committee chairman on Capitol Hill, is asking questions about fees that mutual funds charge investors. He's asking about the commissions trading desks pay dealers. He wants to know if the commissions are excessive. He's asking are soft dollars spent on legitimate services. So he's having a hearing on these controversial issues.

At this moment, it is time to make a suggestion. Someone should mention to Oxley that there is a group called the American Association for Investment Management and Research (AIMR). I hope he has heard of this group. AIMR labored for the past three years - before the bear came out of his cave - on a new set of trading guidelines. Has he read the guidelines? These encourage best execution. The result is part poetry ("the markets are a complex tapestry of interwoven facilities and interacting participants") but mostly the document is a set of recommendations. [See Washington Watch.] Some may complain that the guidelines are farfetched. AIMR recommends, for example, that firms should consider "maintaining appropriate documentation when the commission paid exceeds the acceptable, pre-established range and describing the circumstances that caused the deviation." Farfetched? The AIMR guidelines stress the importance of benchmarks, and elsewhere warn about conflicts in soft dollar arrangements. Not surprisingly, the guidelines have caused a rift on the buyside: On one side are firms that think the recommendations will lead to more regulation. On the other are firms - many of them with sophisticated cost control procedures in place - which mostly see the benefits.

"When it was first proposed way back to benchmark people against an index, there was outcry," recalled Madison Gulley, director of global equity trading at Franklin Templeton Investments. "I don't just look at performance the same as the S&P 500, was one reaction. Well, 30 years later, what do people get compensated for? Beating the index. Not absolute returns." Sure, say others, but flexibility is the best approach. A VWAP execution, for example, is fine. But a VWAP decision can sometimes look idiotic on an urgent trade. It can look idiotic if a trader is unable to execute that trade, because the stock price continues to move more negatively for days outside the VWAP territory. Oxley should pause, smell the roses, and take a close look at the AIMR guidelines. It's hard to believe the questions he is asking are aimed at the same type of industry folks, who spent a short lifetime laboring over an involved new set of recommendations. Do we really need Washington to send alarming signals of possible pending legislation?

John A. Byrne