BlackRock traded using nonpublic data, New York probe finds

January 9, 2014 07:08 AM

BlackRock Inc., the world’s biggest money manager, agreed to end an analyst survey program that New York Attorney General Eric Schneiderman concluded was relied on to execute trades using nonpublic information.

BlackRock agreed to discontinue use of the analyst survey program worldwide. It was developed by Scientific Active Equities, or SAE, an investment group within Barclays Global Investors, which BlackRock acquired in 2009, according to the agreement reached yesterday with Schneiderman.

The agreement comes as money managers are facing heightened scrutiny from regulators following insider-trading probes and assessments of whether their size poses systemic risk to financial markets. Large money managers such as BlackRock, with $4.1 trillion in assets, are among nonbank financial companies that the U.S. Financial Stability Oversight Council is evaluating to determine whether they require Federal Reserve oversight. BlackRock leveraged its size to ensure analysts would respond to the surveys, according to the agreement.

Schneiderman’s investigation found that the design of the survey program “allowed it to capture more than previously published analyst views, including nonpublic analyst sentiment that could be used to trade ahead of the market reaction to upcoming analyst reports,” according to the agreement.

Martin Act

BlackRock’s conduct, according to the agreement, violated New York’s Martin Act, an almost century-old law that gives the state’s attorney general broad powers to target financial fraud.

New York-based BlackRock agreed to pay the state $400,000 to cover the cost of the investigation, according to the settlement. BlackRock didn’t admit or deny the attorney general’s findings, according to a copy of the agreement provided by Schneiderman’s office.

The firm has agreed to cooperate with the attorney general’s ongoing investigation related to the subject matter of the settlement, according to the settlement.

“BlackRock is committed to operating with the highest ethical standards,” Brian Beades, a BlackRock spokesman, said in an e-mailed statement. “This survey was initiated by Barclays Global Investors prior to its acquisition by BlackRock. We have discontinued its use to avoid even the appearance of any impropriety.”

The Scientific Active Equity unit has more than $80 billion in assets globally and offerings include separately managed accounts, hedge funds and mutual funds. Its head and chief investment officer is Ken Kroner, who was an associate professor of economics and finance at the University of Arizona before joining BGI in 1994.

Unit’s Performance

Some of the unit’s active funds underperformed peers in the aftermath of the financial crisis. The unit has seen improved performance over the past several years after making changes such as adding portfolio members and analysts, which were referenced by BlackRock Chief Executive Officer Laurence D. Fink during a conference call in July 2012 and a presentation in May. About 87% of the scientific equity unit’s funds outperformed their benchmarks in the five years ending Sept. 30, up from 47% two years earlier, according to the firm’s earnings releases.

The scientific active equity division relies on quantitative models to make investments. It focuses on consistent and reliable absolute returns through a diversified blend of investment insights that are implemented in a systemic way, according to a marketing document from April. Its hedge funds include European Diversified Equity Absolute Return, 32 Capital Ltd, Global Alpha Opportunities, Emerging Markets Alpha And Pan Asia opportunities, the document said.

Schneiderman’s Investigation

Schneiderman’s investigation relied on internal BlackRock and SAE documents to determine that the survey program was also designed to collect advance revisions to analysts’ published views about the companies they covered.

BlackRock said in one document cited by the attorney general that the purpose of the survey is to “get ahead of analysts’ actions (upgrades/downgrades), get a direct measure of their internal probability distribution around their forecasts and get some more nuanced information about what they really think.”

SAE said in an internal document that the program’s success depended in part on an “analyst’s willingness to really give us advance information,” according to the settlement. Another SAE document cited by the attorney general included the statement, “We’re agnostic as to whether the recommendations themselves are useful investment info. We are trying to front-run” the recommendations.

Survey Program

The survey program, begun in 2003, solicited from stock analysts at “dozens” of prominent brokerage firms worldwide information about the management, competitive position, earnings and views of the companies they covered, according to the agreement.

SAE could use information from its surveys of brokerage analysts to get ahead of future analyst reports on companies, according to the attorney general.

While BlackRock said it only used publicly available information in its surveys, the attorney general said the timing of the surveys and questions included gave it access to nonpublic analyst sentiment.

Schneiderman’s investigation concluded that brokerage firms responded to SAE’s requests while they might have been reluctant to assist retail or other small investors.

One employee said the “obvious and unsaid incentive for most brokers is that BGI is a huge chunk of your paycheck and the analysts better fill out their surveys for such a large client,” according to the settlement.

‘Monetary Gain’

SAE rewarded participating analysts with higher ratings in financial industry magazine rankings important for name recognition and career advancement, and as a symbol of achievement, all of which could “lead to monetary gain both for those analysts and their respective brokerage firms,” according to the agreement. The filing doesn’t name any of the analysts or brokerages.

In September, the Treasury Department’s Office of Financial Research said money managers could endanger the financial system when reaching for higher returns, herding into popular asset classes or amplifying price movements with leverage. The Financial Stability Oversight Council, authorized under the Dodd-Frank financial regulatory law to identify companies that could pose a threat to stability, discussed and agreed to review BlackRock and Fidelity Investments, two people with knowledge of the matter said in November. BlackRock has said the study didn’t link the size of a money manager to risks posed by certain products and practices.

Early Access

Schneiderman said at the Bloomberg Markets 50 Summit in New York in September that his office was looking into combating the advantages won by securing early access to market-moving data. Calling the issue “Insider Trading 2.0,” Schneiderman said the combination of high-speed trading and early data access unfairly sets up a small group of investors to reap enormous profits.

Last year, financial information provider Thomson Reuters Corp. reached a deal with Schneiderman’s office in which it agreed to stop providing consumer survey data from the University of Michigan to certain high-frequency traders two seconds before other investors. Thomson Reuters competes with Bloomberg LP, the parent of Bloomberg News.

BlackRock, co-founded by Fink in 1988, was largely a fixed- income manager until the mid-2000s. The firm diversified beyond bonds through acquisitions including that of State Street Research & Management Co. and Merrill Lynch & Co.’s investment unit to add stocks and other assets. Its purchase of Barclays Plc’s investment division made it into the world’s largest asset manager.

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