One of the SEC’s MiFID II No-Action letters issued a few weeks ago have prompted asset managers to question whether they now have greater flexibility to pay for US sell-side research from their P&L’s or via an RPA. This article reviews the issues raised by this letter.
SIFMA No-Action Letter
The SEC’s response to SIFMA’s letter regarding concerns that research payments received by US broker-dealers from asset managers subject to MIFID II might lead the SEC to take enforcement action against these brokers under the Investment Advisers Act of 1940 revealed a very narrow set of circumstances where the SEC would not recommend action. This includes:
- The asset manager making these research payments are subject to MiFID II, and therefore is directly obligated “to pay for the research services from its own money, from a separate research payment account (“RPA”) funded with its clients’ money, or a combination of the two;” or
- The asset manager subject to MiFID II retains a “non-EU domiciled investment manager who is contractually required to comply with MiFID II or equivalent protections (e.g., setting budgets, accounting for research inputs, and having systems and controls to ensure that the receipt of research does not give rise to certain conflicts of interest).” In this case, US broker-dealers could accept research payments from these non-EU “contracted managers” without fear that they would be brought up on enforcement action that they were in violation of section 202(a)(11) of the Investment Advisers Act of 1940.
The SEC no-action letter went on to clarify that this finding would be for a Temporary Period (30 months from the implementation of MiFID II) after which they may choose to renew these assurances or not.
Despite the narrow set of circumstances outlined by this no-action letter, a few global asset managers have concluded that it creates a loophole which removes the barriers US broker-dealers have with accepting research payments from an asset managers’ P&L or from an RPA as long as the asset manager is under contract to comply with MiFID II.
A few global asset managers have even gone so far to suggest that this contract requiring MiFID II compliance could be between any two managers (e.g. a US pension fund and their US asset manager).
In addition, some argue that the SEC’s no-action letter allows the non-EU manager who is under contract to comply with MiFID II the freedom to pay for any and all research they receive from their US brokers via P&L or through an RPA.
However, we do not agree with these conclusions. First, it is clear that the SEC no-action letter requires that a non-EU manager be contracted to comply with MiFID II by an asset manager who is subject to MiFID II. Most market participants we have spoken with agree that this contractual relationship is likely to be a sub advisory relationship between the two firms.
It is unclear to us what research a “contracted manager” can pay for under this no-action letter. If this contract refers to a sub advisory relationship, then it would make sense that the SEC would argue that the “contracted manager” can only pay a US broker via P&L or RPA for the research specifically used to support the mandate they have with the MiFID II asset manager.
The most important fact to remember about this no-action letter is that it does not require that a US broker-dealer accept P&L or RPA payments for their research. It merely provides them comfort that under certain circumstances they can accept these payments without fear they will be charged with a violation of the Investment Advisers Act of 1940.
The no-action letter still allows US brokers to evaluate each situation to determine if it is consistent with the SEC’s no-action letter. Thus, if legal counsel at a sell-side firm concludes they can only accept P&L or RPA payments for their research from a “contracted manager” if they believe that research can reasonably be shown to support the sub advisory relationship the “contracted manager” has with a MiFID II manager, then they can refuse that firm’s payment for any unrelated research.
We admit that this no-action letter is still unclear in certain respects. For example, it is not clear what type of contractual arrangement is acceptable to the SEC. It is also unclear what research a “contracted manager” can pay a US broker for via P&L or RPA. We would not be surprised to see SIFMA try to get clarity on these and other questions in the coming months.
Despite these uncertainties, we must conclude that the SEC’s no-action letter response to SIFMA’s request regarding the Investment Advisers Act of 1940 is not the open door some US pension funds and global asset managers were hoping for. In our minds, this letter does not allow US broker-dealers to accept P&L or RPA payments from asset managers who are not subject to MiFID II, except in very specific circumstances.