Another scandal is hitting the world of stock surveillance and reinforcing the need for all market participants to take a long-term view of shareholder value. At the heart of this latest debacle is some companies’ desire for up-to-the-minute information on their beneficial holders, and a willingness on the part of third parties to fulfill their insatiable appetite for news on institutional holdings. Apparently this has led to data leaks in the carefully constructed chain of trade settling, designed to protect institutions’ identities, and the SEC is now on the case.
The story begins in summer 2004 with a former CIBC Mellon employee getting caught providing data about the holdings of a particular security to a third party. CIBC notified regulators in Canada and the US, and they are now conducting investigations. ‘We have been cooperating with regulatory agencies as they need information,’ says Cheryl Ficker, manager of PR and communications at Toronto-based CIBC Mellon. ‘What we were able to determine was that the employee was giving the information to individuals at third party firms.’ The SEC has allegedly issued subpoenas to several surveillance firms requesting information.
Virtually all public companies conduct stock surveillance in some form, whether it’s buying stockwatch services or paying for Depository Trust & Clearing Corporation data, in the case of US-listed firms, or both. To say the practice is central to investor relations is an understatement. It became a standard part of IR in the 1990s when the threat of corporate takeovers died down and third parties found a new use for their institutional tracking data. Many IROs use surveillance to measure their IR efforts and are relied upon to deliver insight into who is buying and selling a company’s shares on a regular, sometimes daily, basis.
This is not the first time questions have been raised about how surveillance firms gather data on institutional holdings. In 1997 a former DF King stockwatch professional was found posing as a Bear Stearns employee to gain information on institutional holdings. Bear Stearns sued DF King, which subsequently decided to get out of the stock surveillance business altogether as this was not the first time an employee had obtained information about beneficial owners of securities held by Bear Stearns. ‘[Given this], I was surprised anyone would be in a position where questions could arise as to the appropriateness of his or her dealings with custodians,’ comments Elizabeth Corse, director of investor relations at Missouri-based Savvis Communications.
Tracking the trackers
While unable to confirm an ongoing investigation, Stephen Cutler, head of enforcement at the SEC, says, ‘We are interested in ensuring there are no leaks of non-public material information in the trading chain.’ The commission is also sensitive to the potential for insider trading should this information get into the wrong hands.
So far the only surveillance firm to go public about the SEC investigation is Thomson Financial, which sent out a release on October 18 confirming its receipt of a subpoena from the commission asking for documents related to its capital markets intelligence (CMI) unit. For its part, Thomson is taking action by conducting an internal investigation of its CMI group – an investigation that has resulted in the departure of several senior CMI executives.
‘The SEC is not concerned about the collection of information, but about the misuse of information for trading purposes,’ says John Wilcox, vice chairman of Georgeson Shareholder. Georgeson has been collecting data on beneficial owners for decades and ran a surveillance business alongside its proxy services until 1998 when it sold the surveillance arm to Thomson Financial.
Following Computershare’s acquisition of Georgeson, there is once again a stockwatch arm to Georgeson through Computershare Analytics. As Wilcox explains: ‘The need to collect data on beneficial owners arises from the regulatory schizophrenia that mandates full disclosure on the part of companies, and that they communicate to all shareholders, but then denies access to timely information on who those beneficial holders are.’
But institutional investors are avid about maintaining their anonymity. Mutual funds, which report quarterly, are particularly guarded about their investment strategies and holdings, and are concerned about data leaks from custodian banks.
‘We’ve long worked to protect the confidentiality of our holdings in order to ensure our proprietary information is used solely for the shareholders of Fidelity mutual funds,’ comments Vincent Loporchio, a spokesman for Fidelity Investments, the world’s largest mutual fund provider. ‘We are very concerned about the disclosure of information regarding our holdings; it can affect the price of a security if individuals have knowledge of what we are buying and selling.’
As such, it’s unlikely the SEC’s current investigation will result in further transparency regarding beneficial holders. There are, however, several campaigns pushing for changes to the current chain of custodians and intermediaries that make it difficult for companies to identify shareholders. The Business Roundtable sent a petition to the SEC last April asking for rule changes that would allow companies to identify all beneficial owners, and Wilcox is similarly pushing for companies to be able to better determine beneficial holders for proxy purposes.
Water cooler fodder
Beyond being titillated by a bit of industry gossip, most IROs aren’t overly concerned about the SEC’s interest in surveillance firms’ data mining. Some have never even considered how surveillance firms cull their data. They simply hire a reputable firm, often recommended by another IR person, and then rely on the surveillance expert to deliver information on institutional holdings and activities on a regular basis. As Corse points out, ‘How many of us actually think about how the dairy farmer treats the cows? We just buy the milk.’
Mickey Foster, former vice president of IR at Maryland-based Millennium Chemicals, has subscribed to surveillance services throughout his career and has always considered it ‘more of an art than a science’. He believes most proxy and surveillance experts get a pretty good handle on which accounts are held by a given institution just by looking at public information. ‘Institutions file 13Fs quarterly,’ he explains, ‘and a combination of that plus looking at the accounts on those dates on a quarterly basis makes it not too hard to infer where people keep their stock using all the public data.’
Others, however, wonder how surveillance firms ferret out the identity of beneficial holders. ‘It is a curiosity – how do they get access to that information?’ asks Derek Cole, director of investor relations for Colorado-based pharmaceutical company Myogen. ‘Most [surveillance firms] look at that as their proprietary black box; they have unique relationships with people who can get access to this information but it is never spelled out how that actually works or how they do it.’ The idea of having close ties on the buy side also raised a red flag for Corse when she was listening to one company’s pitch. ‘One surveillance provider said, We have an in at Fidelity that nobody else has, and I thought that didn’t necessarily sound like what I wanted to hire,’ she says.
For his part, Cole has used surveillance firms in the past but having spent most of his 13-year IR career working for mid and small-cap companies, the size of his IR budgets hasn’t justified spending on these services regularly. ‘I generally avoid using stock surveillance except on a project basis – such as before a major news announcement,’ he explains. ‘That is far more beneficial for a small-cap company.’ Instead Cole relies on monthly DTC reports and typical regulatory filings retrieved through Nasdaq Online and Shareholder.com to track who is in and who is out of the stock.
Do it yourself
However, DTC data and 13Fs are extremely limited in terms of what they reveal to IROs. A DTC report shows where a company’s stock is held once a trade has been cleared, which can take three days. But it divulges only the total position at a given custodian bank, not how many investors are in the stock. In other words, you might find out the total ownership of General Motors shares held at Citibank but not a breakdown of that ownership. The SEC mandates that the DTC provides companies with access to these reports, and companies may choose to authorize third parties to receive this information.
Quarterly 13F filings show an investment manager’s aggregate holdings of certain securities. Even more than with section 212 filings in the UK, 13Fs are fairly out of date once they reach the IR person’s hands. They are also incomplete in terms of what they reveal about an institution’s holdings. For instance, they show only exchange-traded or Nasdaq-quoted securities, excluding other types of securities, such as foreign securities not traded on a US exchange. Also, portfolio managers can choose to exclude information from the 13F that reveal their ongoing strategy at the time of filing. ‘And there is no penalty for not filing a 13F – there are certainly lots of institutions that don’t do it,’ notes David Cooke, founder and president of Shareholderidentification.com, a Toronto-based surveillance firm.
By contrast, surveillance firms deliver reports showing who a firm’s beneficial holders are, often with surprising accuracy. ‘Thomson would do a daily report that detailed how our stock was doing relative to our peer group and a weekly report that showed which institutions bought and sold; specifically, who our top 50 holders were,’ reports Foster, who has subscribed to Thomson’s surveillance services in the past. ‘Every Monday it got the tape from the DTC and it didn’t take it too long to do the report.’
Naturally, stock surveillance firms consider their methods proprietary, so detailing how they determine beneficial holders is like giving away the store. Most, however, use a combination of DTC data, regulatory filings and their own databases to trace institutional footprints. ‘We also reach out to investors and tell them we have authorization and are working for a client,’ says Chris Taylor, managing director of market intelligence at Citigate Financial Intelligence. ‘We add that our request is IR-related and is about communicating with shareholders.’ According to Taylor, when approached this way, most institutions are willing to disclose whether they have a position in the company or not.
Fueling the hype
This latest incident with a custodian bank employee leaking information to a third party is symptomatic of some companies putting too much emphasis on short-term results, looking at which institutions are buying and selling in the near term.
‘Some CEOs are market junkies and they put pressure on the IR person to get this information,’ points out Wilcox. In some cases, the IR person may be passing that pressure on to a stockwatch employee who then decides to use illegitimate means to garner the necessary information. In truth, IROs should not need a third party to gain access to confidential, custodian information to conduct a proper IR program.
Surveillance has also grown into a highly competitive industry, which means third parties are always extending and updating their services to attract clients. For his part, Wilcox has always been concerned that the demand for stock surveillance information from clients could grow to a point where it is impossible to satisfy. ‘They would want to know who is behind every block trade, for instance,’ he says. This information is not, however, integral to building shareholder value over the long term. As Cole says, ‘A company’s focus should be on developing long-term investors; when it gets into the circle of what is happening in the short term, it translates into a short-term mentality.’
In fact, so many of the problems of today’s market stem from management or investors focusing too much on near-term results. Perhaps if the SEC went to work on combating this trend, there would be fewer subpoenas to issue.
