Comments Presented By Benchmark Financial Services, Inc. at Chicago Teachers' Pension Fund, Minority Brokerage Roundtable Discussion, October, 2001
"We believe it makes a great deal of sense for the Board of the Chicago Teachers' Pension Fund to have this roundtable discussion where it hears from members of the minority brokerage community, as opposed to continuing to rely solely upon opinions of the fund's managers regarding the fund's minority brokerage policy. Other funds, such as the Ohio Bureau of Workers' Compensation, solicit input from the minority brokerage community, as well as their managers, in monitoring their minority brokerage policies. If you wish to get the two groups working together, getting them together talking seems to make sense.
The Chicago Teachers' policy establishes "best execution" as the threshold standard. Any manager who determines in his judgment that achievement of the minority brokerage goals is not consistent with his best execution duty may simply refuse to do business with minority brokers. We call this the "best execution objection." According to a recent and rare review of compliance with the minority brokerage policy by the fund, only one of the fund's managers was found to be fully compliant, (name deleted), and one was wholly non-compliant, (name deleted). Believe it or not, one of the fund's largest managers had failed to do a single trade with a minority firm in the prior year. There has been limited monitoring of compliance with the policy and no enforcement whatsoever. There are no penalties for noncompliance and no manager has ever been sanctioned or terminated for non-compliance. There even seem to be conflicting views among staff, the board and others as to whether compliance with the policy is mandatory. Certain managers have been told not to be concerned with compliance.
In our opinion, the simplest way of dealing with the "best execution objection" is for the fund to establish at the point of hiring whether the manager can comply with the fund's minority brokerage policy; if the manager cannot, there are plenty of other managers who can and the fund should seek them out instead. Managers who fail to comply with the policy should be required to pay into the fund the amount of commissions they have paid to non-minority brokers that should have, according to the fund's policy, been paid to minority firms. There is precedent for requiring managers who fail to comply with minority brokerage policies to pay into the fund. Other funds, such as (name deleted), have made such demands of their managers.
Make no mistake about it, it is in the best interests of managers to argue against directed brokerage programs, such as minority and recapture programs. The more commission dollars pensions direct, the less managers have for their own purposes including soft dollaring and marketing. Therefore, managers will tell pension funds that they should leave commission decisions to managers and that commission direction cannot be achieved because of "best execution" concerns. Almost always, that is hogwash. Minority and local broker programs operate successfully around the country. As long as managers understand that compliance is mandatory, they will find a way to achieve the fund's brokerage objectives.
With regard to the proposal the fund is considering to restrict participation in the fund's minority brokerage program to firms based in Chicago that are determined by the fund's staff to have a "significant presence" in Chicago, we question the advisability of such an approach. First, there are a limited number of minority firms based in Chicago. Second, is the staff qualified to perform due-diligence reviews of brokerages? Finally, what constitutes a"significant presence?" Do you really want to get in the business of picking and monitoring the minority firms your managers use? This seems like an unnecessarily risky and highly political exercise. This new policy may prove embarrassing for the fund should one of the hand-picked local firms get into trouble or cause a loss to the fund. Rather than get involved in the controversy regarding restricting participation to Chicago firms, we would like to reiterate our support for your goal of increasing minority participation. Minority and women owned firms nationally are still getting less than 1% of the nation's brokerage, even as women and minorities combined likely represent over 50% of the U.S. population. Minority participation in brokerage is an issue that even the managers of "socially responsible" funds fail to address. These managers criticize companies that fail to hire minorities, yet they fail to use minority brokers for their trading.
With regard to the percentages for minority firms in your fund's brokerage policy, we believe they should not be increased but should be enforced. Enforcement will significantly increase minority participation.
Minority firms are qualified to do far more business than they are currently receiving from your managers. How can we say this? Let me give you the following example. Your consultant, (name deleted) is a broker registered with your consultant's affiliated brokerage firm, William M. Mercer Securities Corporation. He is licensed as a general securities representative and holds a Series 7 license. As the owner of a brokerage firm, I am licensed as a general securities representative, general securities principal, municipal securities principal and financial and operations principal. I hold Series 7, 24, 28 and 53 licenses. Both my firm, which is minority-owned and Mercer are fully disclosed brokerages. In other words, we operate similarly through correspondent clearing firms. As of December 31, 2000, Mercer had net capital of $826,000; my firm, Benchmark Financial Services, Inc., had net capital of $2.5 million. I think you would have to agree that a comparison of the two firms would lead to the conclusion that they are at least equally qualified. Yet my firm does less than one-tenth of the amount of brokerage business as Mercer. And all the minority firms in the nation combined do less brokerage business than a single consulting firm such as Wilshire. Why is this so?
Money managers have little problem finding ways to do direct brokerage business to consultants, as is evident from consultants' revenues. (Consultants, on the other hand, are extremely reluctant to disclose their brokerage revenues to their clients or anyone else.) Managers find a way to do business with consultants because they get business from consultants. Managers find it difficult to do business with minority firms, often citing best execution concerns, when there isn't a single minority firm participating in this roundtable discussion that does not offer a correspondent clearing arrangement similar or identical to those offered by consultant brokerages. In summary, it should be no harder for your managers to find ways to do business with minority firms than consultants. What's lacking is the motivation for managers to do business with minority firms and it is up to pensions that feel strongly about minority participation to provide them with that motivation. In other words, funds must tell managers"if you want to manage our money, you must do business with them."
Today we are holding a meeting at the offices of a broker registered with a pension consulting/ brokerage firm. We are discussing the problems related to doing business with minority firms. I look forward to the day when we hold a meeting at a minority firm's offices to discuss the myriad problems of doing business with consultants' brokerages."
Note: Following the meeting, the Board changed the fund's minority brokerage policy, limiting participation to minority firms deemed to have a "substantial presence" in Chicago. Now firms must be "qualified" by the fund's staff in order to participate in the fund's trading.
Setting Standards For The Investment Management Industry
