New York – The U.S. Securities and Exchange Commission issued a letter clarifying that investment banks providing proprietary research can be paid through Client Commission Arrangements (CCAs). This innocuous letter represents a major step in ‘unbundling’ research, removing a large obstacle to the pricing of investment banks’ proprietary research.
CCAs allow money managers to trade with ‘best execution’ counterparties and accumulate ‘credits’ which are then used to pay other third parties for research. Until now, a few of the largest investment banks have refused to take payments for their research through CCAs, arguing that doing so would trigger certain prohibitions of the Investment Advisers Act of 1940 (Advisers Act). Uncharitable observers felt this was simply an excuse to prevent their research from being unbundled from execution since many other broker dealers were accepting payments through CCAs and were apparently not getting into hot water with the SEC.
BNY Convergex wrote to the SEC requesting clarification of the issue, and the SEC responded with a no action letter released this week saying that proprietary research can be paid for through CCAs.
The crux of the issue is a provision of the Advisers Act intended to prevent self-dealing that could arise when an investment adviser acts as principal in a transaction with a client, such as through price manipulation or dumping unwanted securities into the client’s account. The investment banks were arguing that receiving payment through a CCA would effectively create a fiduciary relationship between them and the asset manager’s managed accounts because their research is often tailored to the requirements of the managed accounts. Given this supposed fiduciary relationship, the investment banks would be constrained in executing principal transactions with the managed accounts, and/or potentially subject to the Advisers Act.
The SEC concurred with the BNY Convergex letter, written by Pickard and Djinis, that the provision of research incurred no such fiduciary relationship between the research provider and the clients of the asset manager. Therefore, there was no reason for investment banks not to take payment through CCAs. Large investment banks may still be reluctant to accept payment through CCAs, but they now have no argument against it.
This no-action letter helps to level the research playing field further. Although few in number, the largest investment banks still garner a disproportionate share of research spending. One reason for this is that they are paid through bundled commissions, which make it difficult to determine what is paid for execution and what is paid for research services. CCAs (and their European counterparts, Commission Sharing Arrangements or CSAs), have been one of the main market mechanisms for creating more transparency in the payment for research.
When combined with the recent SEC requirement to clarify in the Form ADV that proprietary investment banking research paid through bundled commissions is in fact a form of soft dollars, will (eventually) help to clarify to fund trustees, pension funds and their consultants that soft dollars does not just apply to the purchase of independent third party research.