Using Bond Trades to Pay for Third-Party Research

ARLINGTON, Va.--(BUSINESS WIRE)-- Today, Professor D. Bruce Johnsen of George Mason University School of Law released a white paper titled “Using Bond Trades to Pay for Third-Party Research.” Professor Johnsen has published several scholarly articles providing statistical evidence that third-party research funded through client commissions leads to higher returns. Using historical data, Horan and Johnsen (2008) showed that for a typical money manager an increase of 1.0 cent per share in the average commission rate increased portfolio performance by 4.3 basis points per quarter.

Professor Johnsen explains how SEC regulations under a Securities Exchange Act safe harbor promote the use of client commissions in both equity and fixed income transactions. In fixed income transactions a money manager may acquire third-party research on bond trades executed in either an agency capacity or in a “certain riskless principal capacity.” Professor Johnsen notes third-party research on bond trades executed by a “non-positioning broker dealer acting as an agent” is clearly protected by the safe harbor.

Johnsen also discusses changes in bond distribution channels since the repeal of Glass-Steagell, which allowed commercial banks to re-enter the brokerage business. Specifically, Johnsen notes that it is often more efficient for a money manager to buy bonds through an “inter-dealer broker,” acting as an agent, who has contacts with a large number of dealers than it is to buy from the sales department of a bank.

Notable Points:

• According to a 1975 Senate Report on the use of client commissions to pay for investment research, “research [is] not an expense of management.”
• Section 28(e) of the Securities Exchange Act of 1934, added by Congress in 1975, provides money managers with a safe harbor to “use client funds to obtain ‘brokerage and research services’ . . . without being presumed to have breached their fiduciary duties or violated federal law.”
• An authoritative 1998 SEC report recognizes that “research is the foundation of the money management industry. Providing research is one important, long-standing service of the brokerage business.”
• In its 2006 Guidance, the SEC stated that “the safe harbor encompasses third-party research and proprietary research on equal terms.”

The paper is available for download at: http://www.law.gmu.edu/pubs/papers.

About Professor Johnsen

D. Bruce Johnsen is Professor of Law at George Mason University. He has authored a series of research papers demonstrating the efficiency of client commissions to obtain investment research, including “Portfolio Management, Private Information, and Soft Dollar Brokerage: Agency Theory and Evidence,” recipient of the American Association of Individual Investors’ Best Paper award in 1999.

Professor Johnsen previously served as an assistant professor in the Department of Legal Studies at the University of Pennsylvania’s Wharton School and as a Financial Economist in the Office of Economic Analysis at the United States Securities & Exchange Commission. He is a graduate of Emory University School of Law (J.D., 1985), and the University of Washington, (Ph.D. Economics,1987).

CONTACT:

for Professor D. Bruce Johnsen
Gregory FCA Communications
Luke Napoli, 610-228-2127
Luke@GregoryFCA.com

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