On November 4, 2019, the SEC extended its “no-action” relief permitting US broker-dealers to accept cash payments for its research from asset managers who are subject to MiFID II until July 3, 2023. However, the SEC’s most recent no-action letter didn’t address cash payments from asset managers not subject to MiFID II – or did it?
The extension of the SEC’s “no-action” letter enabled broker-dealers to continue to accept cash payments from MiFID II subject asset managers with no fear that the SEC would take legal action against those brokers for a violation of the Investment Advisers Act of 1940 (“Advisers Act”).
Use of Client Commission Arrangements
The SEC’s extension letter also provided clarity for asset managers not subject to MiFID II revealing a few ways they could pay for US broker-dealer research without relying on bundled commission arrangements. The first approach the SEC outlined was the use of CCAs which was discussed in footnote 8 of the November 4th “no-action” extension.
A CCA is a form of commission sharing agreement where a broker separates equity commissions they receive into an execution portion (which they keep) and a portion payable for research which is placed in a research pool for the clients benefit. The asset manager can direct the executing broker to pay for research from third-party brokers from the research pool on their behalf. Below is the footnote:
[8] As a separate matter, we understand that, in connection with CCAs, such as those referenced in footnote 4 above, the money manager in some cases (a) may not have a trading relationship with a broker-dealer that receives commissions for research from the CCA or (b) to the extent it does have a trading relationship with such a broker-dealer, the trades may not relate to that broker-dealer’s research. We understand further that some broker-dealers have questioned whether accepting client commissions to pay for research in these circumstances would affect the availability of the exclusion for broker-dealers from the definition of “investment adviser” under the Advisers Act. In this regard, the staff believes that the Commission was cognizant of these types of CCAs when it issued its 2006 interpretation, and the Commission did not question the availability of the broker-dealer exclusion in the context of these types of CCAs. See Commission Guidance Regarding Client Commission Practices Under Section 28(e) of the Securities Exchange Act of 1934, Exchange Act Release No. 54165 (July 18, 2006), 71 Fed. Reg. 41978 (July 24, 2006). Therefore, the staff believes that the use of these CCAs does not affect whether the broker-dealer exclusion may be available in connection with the receipt of payments for research under section 28(e).
The SEC clarified that US broker-dealers could accept payments for research on behalf of asset manager clients from other executing brokers via client commission arrangements. They also made clear that the broker-dealer receiving CCA payments do not have to have a trading relationship with the asset manager purchasing the research.
CCAs have been used by many in the US markets since a 2007 Goldman Sachs “no action” letter. However, not all broker-dealers have felt comfortable accepting CCA checks from other brokers. These brokers have been concerned that accepting these cash payments from CCA pools would run afoul of the 1940 Advisers Act.
The language in footnote 8 has brought some level of comfort to a few of these broker-dealers who previously refused to accept CCA checks from other brokers to pay for their research – particularly if they did not have a trading relationship with the asset manager wanting to purchase their research. Banks like Credit Suisse and Barclays have recently taken a more accommodating stance with regards to accepting CCA checks from other brokers. At least one broker, Morgan Stanley, still refuses to provide its research to clients who don’t have a trading relationship with the bank.
Reimbursements for Research Payments
A related approach the SEC tacitly supported in its no-action extension letter was the commission reimbursement model used by MFS, Capital Research, and Nuveen.
In this approach, the asset manager uses CCAs to pay US broker-dealers for their research. However, each of these asset managers has decided to pay for the research they use from their P&Ls. Consequently, these managers reimburse their fund clients for any research payments that are made using CCAs. The SEC addresses this approach in footnote 4 of the recent “no-action” extension (see below).
[4] See, e.g., Letter of the Securities Industry and Financial Markets Association (Mar. 21, 2019) (discussing the costs of a broker-dealer registering as an investment adviser) and Letter of the Securities Industry and Financial Markets Association (Aug. 2, 2019). In addition, the staff understands that some investment advisers are using reconciliation or reimbursement in conjunction with CCAs to make payments for research to broker-dealers. See, e.g., Letter of Capital Research and Management Company (Apr. 18, 2019) (stating that it is currently bearing the cost of research through the combination of CCAs and a reimbursement program); and Letter of Sidley Austin LLP (Mar. 19, 2019) (stating that some investment advisers are bearing the cost of research through the combination of CCAs and a reimbursement program).
Our Take
At least five US brokers including Bank of America Merrill Lynch, Deutsche Bank, Jefferies, Nomura Securities and BMO Capital Markets previously decided to register their research departments as investment advisers to enable any asset manager to use cash to pay for their investment research.
However, it has not been clear if US asset managers could pay any other US brokers for their research using cash. The November 4, 2019 letter from the SEC extending its temporary no-action letter enabling US brokers to accept cash payments from asset managers subject to MiFID II, also provided some clarity for firms not subject to MiFID II.
The no-action letter explained that US brokers can accept CCA checks for their research on behalf of US asset managers, even if they don’t have a trading relationship with them. This language has already prompted some investment banks to take a more flexible stance in accepting CCA payments for their research from other brokers. The letter also acknowledged that asset managers who are currently reimbursing fund clients from their P&Ls for research paid for with CCAs have not done anything that the SEC considers inappropriate.
In the SEC’s November letter it mentions that US regulators want to allow additional time for “market-based solutions” with respect to payments for research in the US and Europe to evolve further. We are particularly interested to see whether any new market generated solutions do spring up which will give US and EU asset managers more flexibility to pay for research without having to rely on an additional extension of the SEC’s “no-action” letter after the current July 3, 2023 expiration.