Wednesday, July 24th, 2019
pay to play

Depending on the part of the investment world that you’re involved in, “pay to play” can mean a variety of different things.  At the core of most of the situations is a payment for access to and potential influence of those charged with stewarding capital of behalf of others.  A variety of intermediaries can be involved; in each of the cases below, asset managers play a role, as do other parties.

Let’s start with investment conferences.  The attendees at some may be in the “institutional” realm, investing on behalf of pension plans, foundations, endowments, etc.  Other conferences are aimed at the financial advisors who work with individual investors.

Many of the conferences are largely or completely pay to play.  The agendas are packed with those who have bought sponsorships, which include the right to present their ideas (read: products and services) to the attendees — and their wishes can also shape the other topics that are deemed to be appropriate, as a story from Robin Powell indicates.The Evidence-Based Investor | This relates Powell’s experience of being asked to leave a conference at which he had spoken.

The net effect is one of basing the content of a conference on the ability to pay, which favors larger firms and effectively blocks out most others, no matter the value that they can add.  Thus, you can usually judge the quality of an event simply by its method of speaker acquisition, so compare the agenda with the list of sponsors in advance.  If the main purpose of a conference should be the education of the attendees, many of them today aren’t structured to meet that goal.

(Sharp observers might argue that, as a speaker at conferences who doesn’t pay to speak, I’m talking my own book.  I am, which means I also understand the implications, having refused to play.  And, as an attendee at conferences over the years, I have been frustrated when the content is driven by something other than the timeliness and incisiveness of the material.)

Last year, Jason Zweig wroteWall Street Journal | The article was titled, “The Free Trips Your Financial Adviser Takes Could Cost You.” about excursions put on for advisors to luxury destinations, all expenses (including travel) paid by asset managers with whom they would have the opportunity to rub shoulders and on whom they could do “due diligence.”  As someone who is involved in assessing and developing due diligence practices, I can say that this situation is tailor-made for what is called “analyst capture,” not effective due diligence.  The asset managers have paid the sponsoring firm (and, let’s be honest, the advisors) nicely for that opportunity.

(You could say that I’m conflicted on this one too.  I lead workshopstjb research | Here is some basic information about them. on due diligence and manager selection that focus on improving the odds involved in the endeavor of active management.  Learning to crack a manager’s narrativethe research puzzle | An earlier posting was called “cracking the narrative.” is foundational, something that is hard to do when you are accepting favors from them.)

Other kinds of gatekeepers have the potential to be influenced too.  Institutional investment consulting firms sit between asset managers and the enormous pools of assets that they would like to manage.  For some of them, their business models have included ways of making money from asset managers via data, services, conferences, and the like.SSRN | Some of those potential conflicts are laid out in a 2013 paper by Jay Youngdahl, “Investment Consultants and Institutional Corruption.”  It’s not a stretch to imagine that those who pay for those things might get some favorable treatment along the way.

So-called “corporate access” is another practice that favors large asset managers over other investors.  Firms pay sizable fees to investment banks to get special access to the CEOs of public companies.  Under Regulation FD,SEC | Here’s a little summary of it. those meetings are prohibited from including any material nonpublic information.  But from the prices paid for the access, something of value must be being exchanged.  Oh, and by the way, the analysts that make the arrangements are generally expected to have buy recommendations on the stock and even be “brand ambassadors.”Wall Street Journal | This article provides details.  Talk about perverting the process.

Another industry norm results in mutual funds paying brokerage firms to be on their “platforms,” the lists of approved products.  The brokers get more money through that revenue sharing and the asset managers get more assets (and therefore more fees) themselves.  The question is whether those arrangements benefit the client — the selection of products for a platform is not just driven by investment merit, but by a firm’s own income statement.Marotta Wealth Management | Here’s one example that prompted an advisor’s concern.

In the hedge fund world, a nice chunk of the sizable fees that investors pay can go to placement agents and others involved in the selling of the fund rather than the management of it.Bloomberg | This article provides some examples.  That’s probably not what most investors expect; they are told they are getting the “best.”  Maybe that’s not all that’s at work.

The most high-profile usage of the term “pay to play” of late has stemmed from a 2010 rule by the Securities and Exchange Commission prohibiting investment firms from doing business with government entities if they have made political contributions to the elected officials involved.  Since its implementation, there have been settlements with firms charged with violating it; given the mammoth size of many government pension plans, no doubt there will be additional attempts to subvert the rule or find some other way to influence those involved.

As indicated before, these wide-ranging examples have one thing in common:  They all involve asset management firms on the “paying” side of the transactions.  But there are a lot of potential disclosure and conflict of interest issues for all of the parties involved, not just the managers.

To be clear, many of the arrangements included here aren’t prohibited, even though they can work against the interests of the owners of assets in one way or another.  Better disclosure is needed, but that doesn’t necessarily require more regulation.  We all should learn to ask, “Who’s paying for what?”

If we don’t, we won’t know if we’re getting played.