NASDR to Media Darlings: Disclose Your Conflicts

Life may get tougher for industry media darlings now that the National Association of Securities Dealers Regulation wants to require brokerage employees to disclose their conflicts of interest when discussing securities on television, radio or in print.

The self-regulator is urging the Securities and Exchange Commission to adopt similar rules, but new SEC Chairman Harvey Pitt still is setting the agency's agenda. "We still believe that all securities professionals should be regulated by the same uniform-rule language, but we believe it was necessary to act now," NASDR spokeswoman Nancy Condon told Financial Advisor.

The NASDR proposal says commentators affiliated with broker-dealers must disclose their firms' and their personal financial stakes in securities, including 5% ownership, any warrants, options or rights to purchase securities and any investment banking compensation the firm has received.

Even without an SEC rule, financial advisors who are affiliated with broker-dealers could find themselves caught in the snare of the issue, particularly if they are on radio or televison discussing stocks.'s James Cramer, a hedge fund manager cum journalist who has appeared on CNBC, declined to comment on the NASDR initiative. Cramer once created firestorms by making recommendations about stocks he owned without disclosing it.

Behind the scenes, things might be worse. Analysts at nine major unnamed brokerage firms used their positions to profit from the companies they covered, an SEC investigation found.

Plaintiff attorneys are on the case, too. Technology analyst Mary Meeker, a former media darling, and her employer, Morgan Stanley, have been named in three lawsuits alleging Meeker provided biased research on companies such as AOL Time Warner to retain them as investment banking clients.

Mergers Expand The Reach of Leading Firms

Conslidation among asset-management firms is accelerating as many companies look to build their client bases in a soft market environment.

For example, Eaton Vance Corp. recently announced it is buying 80% of Fox Asset Management Inc., an institutional investment-management firm. Eaton Vance will pay $32 million in cash and stock to be followed by payments of up to $30 million each in 2005 and 2006, contingent upon certain financial performance criteria. Fox, based in Little Silver, N.J., will become a subsidiary of the Boston-based fund company.

"Fox's strong investment management capabilities are a strategic complement to Eaton Vance's overall business, both in terms of its focus on institutional clients and its participation in the rapidly growing managed account business," says James B. Hawkes, Eaton Vance's chairman and CEO.

Fox, with $2 billion under management, focuses on separately managed accounts for institutions and broker-dealers. Clients include pension funds, Taft-Hartley funds, endowments and foundations. It also is sub-advisor for several mutual funds.

In another announcement, Oppenheimer Acquisition Corp., the parent company of Oppenheimer-Funds Inc., revealed it plans to buy hedge fund and alternative-investment specialist Tremont Advisers Inc. The purchase, at a price of $19 per share, is expected to close in the beginning of the fourth quarter. Tremont's board of directors approved the sale July 9.

In acquiring Tremont, Oppenheimer officials say they are trying to meet increasing demand among its clients for nontraditional investments.

"There is a growing interest among high-net-worth investors and institutions alike in hedge funds and other alternative-investment products that seek to provide positive returns regardless of the direction of the stock market," says John V. Murphy, OppenheimerFunds chairman and CEO.

Tremont will operate as an independent subsidiary after the sale. Its products will be offered through Oppenheimer's MassMutual distribution network. Oppenheimer Acquisition Corp. is a subsidiary of Massachusetts Mutual.

Tremont, based in Rye, N.Y., manages, advises or administers more than $8 billion in alternative investments, including $1.5 billion in 13 proprietary funds. Oppenheimer manages $127 billion in assets held in more than 5 million shareholder accounts.

Also, managed account provider EnvestNet and Portfolio Management Consultants expected to close a merger by August 31. The company will be called EnvestnetPMC, which the firms say will be the second-largest provider of managed account services to the independent advisor market. The new company will be based in Chicago and maintain offices in Denver and New York.

Alternative Investments: Good Medicine, But Read Warnings

Advisors need to consider hedge funds, managed futures and other alternative investments to stay competitive in a changing market, a new study suggests. But in using these investments as medicine for dealing with shrinking market gains and narrowing avenues for diversification, advisors have to remember to do one thing: Read the warning labels.

"These products are like prescription drugs," says Mark P. Hurley, CEO and chairman of Undiscovered Managers, which released a report on alternative investments in July and is considering building its own fund-of-funds platform. "Used correctly, as prescribed by someone who knows what they're doing, they can create marvelous results."

But as the study points out, there are many potential pitfalls to using these investment vehicles, which include hedge funds, managed futures, venture capital, mezzanine financing, leveraged buyouts, private real estate investments and REITs. Chief among them is that they largely are unregulated, without many of the government-mandated safeguards that are built into more traditional products. And hedge fund or private equity managers don't typically register with the Securities and Exchange Commission as investment advisors.

"Consequently, when things go bad in the area of alternative investments, they go really bad," the report says. A noteworthy example is described in a complaint filed by the SEC in October against Ashbury Capital Partners that accuses the hedge fund and its CEO of falsifying financial statements and using shareholder money for personal use.

Why does Hurley view this as inevitable? Because evidence of a growing demand for alternative investments already is clear from the way institutional investors have moved money into the products, he says.

He cites two main factors responsible for the trend. One is the growing view of many experts that a prolonged period of relatively low annual gains, 6% or less, lies ahead for the broad equity market. Another factor is the view that typical diversification techniques don't cut it anymore as traditional market sectors move more in lockstep with one another, chiefly as a result of globalization.

That's why endowments made a gradual shift to hedge funds and other absolute-return strategy products all through the bull market of the 1990s, says Undiscovered Managers President Robert L. Worthington. It was more for the sake of diversification than a quest for greater gains, he says. "There is inherent value in them, and the inherent value is they derive their returns in other than directional moves of the market," Worthington says.

Aggregate performance data also buttresses the case for alternative investments, Hurley notes. The report finds that, based on 1990 to 2000 data, the addition of alternative-investment products to traditional portfolio types led to an improvement in returns. The study compared a traditional aggressive equity portfolio, composed of 50% large-cap, 20% small-cap, 15% international and 15% fixed-income vehicles, with a similar portfolio but included 25% alternative investments. During the 11-year period covered by the data, the revised portfolio outperformed the traditional one on an average annual basis of 14.53% to 12.36%.

But Hurley, again pointing to the fact that advisors need to do thorough due diligence when dealing with alternative investments, says behind these numbers lies a playing field dotted with land mines. "These are aggregate returns, and let me tell you, you don't necessarily get the aggregate," he says. That's because of a large variance in the performance of alternative-investment managers-much wider than is found in traditional sectors.

During the 10 years ending December 31, 1997, for example, the performance gap between venture-capital managers in the first and third quartiles was 21.2%. This compared with a gap of 1.2% in the U.S. fixed-income sector and 2.5% in the U.S. equity sector.

If numbers such as these cause advisors to shudder, they should, Hurley says. That's why advisors need to look at alternative investments as a "another level of sophistication" they need to learn to stay competitive, he adds.

Among other things, the report concluded that ignoring alternative investments is counterproductive because all indications are they are going to continue to become more popular. "What we're saying is the fact that these things are complex and difficult does not mean they're going to go away," he says. "Ignoring the asset class is like saying, 'Heart surgery is complicated, and I don't want to offer that because people could die.' But guess what-then you're not going to be competitive."

Advisors Fall Short On Advising Their Own Employees

Financial advisors seem to be skimping in how they communicate their in-house policies and procedures to employees, according to a recent study.

The study of independent fee-only advisors found that just 22% have executive policies and procedures manuals, and only 13% have employee handbooks.

While small firms were more likely to be short on such documentation, even larger firms were lagging, according to the study by Tiburon Strategic Advisors, based in Tiburon, Calif. Only 30% of firms with more than $100 million in assets under management had policies and procedures manuals, compared with 20% for smaller firms. And only 20% of larger firms had employee handbooks, compared with 10% for smaller firms.

Tiburon noted that the impact of the missing documentation could be far-ranging, impacting things such as employee morale, employer liability and recruitment.

"Advisors need to institutionalize their processes if they want to grow," says Chip Roame, managing principal of Tiburon.

Betty Gilbert, a consultant who helps companies develop such documents, says employee handbooks and policy and procedure manuals shouldn't be viewed as luxuries. In addition to giving employees concrete information on what's expected of them, she says, "if legal questions arise, these documents go a long way in convincing the courts that employees were cognizant of company policies and that supervisory staff treated employees consistently."