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November 13, 2007

CCAs Gain Traction

Regionals Under Siege

By Peter Chapman

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The drive by money managers to unbundle has small- and mid-tier broker-dealers squirming. Whether it is via direct payment or indirectly through client commission arrangements (CCAs), many money managers are determined to value and pay separately for research and execution services. The trend, which results in fewer orders being sent to brokers' trading desks, is starting to cause pain at regionals and boutiques.

"Anything that distances a firm from its clients is viewed as a threat to the business model," Doug Woodcock, president of D.A. Davidson & Co.'s equity capital markets group, said at a recent industry conference. "And clearly, client commission arrangements do. Everybody is trying to maintain a comprehensive relationship with their best clients. That includes a trading relationship."

CCAs create distance between a brokerage and its institutional clients because they eliminate interaction between the broker-dealer's trading desk and the client. Money managers, which traditionally paid for research with order flow, are now starting to direct more of their trades to a small, elite group of large trading houses. Those firms then pool the commissions and distribute them to the research providers aligned with their CCA programs on a periodic basis.

One-on-One

Generally, mid-tier firms would prefer to negotiate separate agreements with specific clients one-on-one," Woodcock said. "But the reality is that that is not the way it is going to happen. Pooled commission agreements such as CCAs are the way this will fall into place." Davidson is a regional brokerage headquartered in Great Falls, Montana.

The disconnect is causing bruised feelings among the brokers that function as "research providers" in the CCAs. Not only are their trading desks getting the cold shoulder, their firms are facing declining revenues. While CCAs now represent only a small portion of these brokers' revenues single-digit percentages, according to an informal survey conducted by Woodcock that portion is growing.

"It's growing fast," Woodcock told attendees at this year's Securities Industry and Financial Markets Association Institutional Brokerage Conference. "In many cases, it is the fastest-growing component of the revenue stream." Woodcock, formerly Davidson's director of research, said he surveyed about a dozen mid-tier brokerages "all with valued research products."

At one regional, the hard dollar percentage is already in the double digits. Nik Fisken, director of research at Arkansas' Stephens Inc., says hard dollar payments represented 20 percent of its institutional revenues. "They were up 250 percent in 2006 and 85 percent year-to-date," Fisken told attendees at the SIFMA confab. For Stephens, one hard dollar is the equivalent of $1.35 in commissions, Fisken explained.

Behind the use of hard dollars to pay for research is a drive by money managers to get best execution. While a given brokerage may provide sterling research, it could be relatively weak on the trading end. CCAs then allow the money manager to use the brokerage for research but bypass it when it requires trading.

Best Execution