The main elements of the broker vote revolve around research and best execution. To better understand this dynamic, look at the traditional roles on the sell and buy sides and their lines of communication. On the sell side, there are four main actors: research analysts, research salespeople, salestraders and position traders. Their counterparts at the buy side are research analysts, portfolio managers (PMs) and salestraders.
Sell side research analysts are the idea generators for an investment bank. They follow a sector or industry and get to know the companies intimately through analyzing financial statements, talking to the company's officers, following industry news and speaking to suppliers, clients and competitors of the firm. They compile all this information into opinions about the prospects for the company's business and stock price. This is known as the "Mosaic Theory". The analysts interface with the buy side's research analysts and PMs; giving them their talking points about different companies. Their recommendation is often boiled down to a buy, hold or sell in the press. The buy side is NOT solely interested in that. They are interested in the thinking process behind an analyst's stock recommendations.
Research salespeople are advocates for their buy side clients. It is their job to obtain the resources needed by them from within the investment bank. This may be a meeting with a sell side analyst or getting them into an industry conference. They market the bank's research capabilities by acting as filters - passing on the most impactful research to a client. For example, if a client has a large position in Microsoft, the salesperson will relay any important research reports regarding that stock to them. A better salesperson may relay news regarding Dell and Hewlett Packard as their sales affect the volume of Windows packages are sold.
Sell side salestraders communicate with the PMs and buy side salestraders. They execute trades and are trying to minimize the transaction prices for the buy side. The calculation of any investment return is dependent on the price of the security when bought. They also act as filters of the investment bank's research. Their ideas are more geared to day trading than any long term investing. Most of the orders are originated by the buy side. At times, they will ask the sell side to facilitate a trade by committing capital. This is something only the largest institutional clients are able to ask for and get.
Position traders interact with the exchanges and salestraders. They have a trading book which has a profit and loss (p/l) statement that is measured constantly. When an order comes from the buy side, the broker/dealer's salestrader will execute the trade through the position trader. Ideally, it will be in the book's current inventory. This is where some friction will appear between the sales and position traders. If the salestrader executes the trade at a good price, the customer will be happy and be more willing to allocate trades to the firm. However, a good price adversely affects the trading book and the p/l statement.
All four roles are large contributors to the broker vote. Whether research or trading is more important is firm specific although each side thinks that they contribute more to the vote than the other. Beyond the client service aspect, there are other items that influence commission allocation such as:
- Is there is a prime broker relationship?
- Corporate access
- Does the investment bank sell the buy side firm's funds?
We will explore these factors later.
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