CCAs Versus CSAs: When is a Commission Not A Commission?


New York, NY – The SEC recently issued a “no action” letter in response to a question from Goldman Sachs about whether research providers who participated in its Research XPRESS platform needed to be registered as broker dealers to be paid out of a pool of client commissions.  The end result will enable US money managers to do exactly what their UK counterparts have been able to do for the past year – and that is to pay for both broker and non-broker research out of a single pool of commissions.

However, the SEC’s response has caused a little confusion as the no action letter clearly stated that the commission saw no problem if non-broker dealers were paid using Commission Sharing Arrangement, as long as these arrangements fell within certain guidelines outlined by Goldman Sachs.  Unfortunately, the circumstance outlined by Goldman Sachs seemed to be more appropriate for Client Commission Arrangements not Commission Sharing Arrangements.

What is a Client Commission Arrangement?

A Client Commission Arrangement, as defined in the SEC’s interpretive guidance issued in July 2006, is an arrangement whereby a money manager may agree with one of its executing brokers to set aside a portion of the commissions generated from trading for its accounts into a “pool of funds”.  This money manager may later request that the broker-dealer make payments out of this pool to providers of certain research products or services on its behalf.

So How Does This Differ From a CSA?

A US Commission Sharing Arrangement, while similar to a CCA, is different in one very important respect – both participants in the arrangement must be broker-dealers (including the executing broker and the introducing broker).

As a result, a money manager may pay for the research it uses by allowing research providers to “split or share” in the commissions generated from its trades ONLY IF THEY ARE REGISTERED BROKER DEALERS.  This also means that the “introducing broker” must abide by the various rules set out in the July interpretive guidance which define what a broker must do to be “effecting” a transaction.

To add to the confusion, it must be noted that a Commission Sharing Agreement in the UK does not require that both parties are broker-dealers, as non brokers are legally allowed to share commissions.

No Brokers Required

The Goldman letter to the SEC clearly was seeking clarification about whether research providers who participated in their Research XPRESS platform needed to be registered broker dealers in order for clients to direct Goldman Sachs to pay them out of a pool of client commissions.  In other words, Goldman wanted to make sure that research providers did not need to be brokers to be paid using a CCA.

According to a Client Memorandum written by attorneys Larry E. Bergmann (formerly of the SEC) and Roger D. Blanc of law firm Willkie Farr & Gallager, the situation was clarified.  Bermann and Blanc noted that the SEC Staff based their decision not to recommend enforcement action if a research provider receives payments from this type of “pool of funds” even though the research provider was not a broker dealer on the following conditions:

1.     The money manager is responsible for independently determining the value of the research services in accordance with its good faith determination that the service is 28(e) eligible.  The research provider may, in this case, provide some input to the client as to the value of the research service;

2.     The executing broker-dealer is in no ways involved in determining the value of the research service;

3.     The research provider receives payment for its services from a pool of commissions that the money manager and executing broker have previously agreed should be set aside to pay for research services;

4.     Payment to the research provider is not conditioned, either directly or indirectly, on the execution of any particular transaction or transactions in securities that are described or analyzed in the research services; and

5.     The research provider receives payment from a pool of commissions set aside for that purpose, but does not perform any other functions that are typically characteristic of broker dealer activity.

Not Really Commissions

To understand the confusion caused by the “no action” letter, one needs to remember that historically the only US firms that could “split or share commissions” were registered broker dealers.  As a result, many boutique research firms became registered broker dealers in an effort to be paid through shared commissions versus subscriptions.

The rationale was that sharing commissions could lead to extremely high payments if the research provider were to truly add value, whereas a subscription fee did not change based on the amount of value the research contributed to the manager’s investment process.

Despite the confusion caused by the SEC’s “no action” letter, it is clear that money managers can, in collaboration with their executing broker, establish a “pool of commissions” for the expressed purpose of paying for the research provided either by broker-dealers or non broker-dealers.  It also appears that the SEC’s “no action” letter also allows a manager to create one commission pool from which it can pay both B/Ds and non B/Ds.

In other words, as long as the above criteria are met, the research payments from this commission pool are no longer commissions.  Consequently, US money managers will have the freedom to pay any research provider – whether they are B/Ds or not – from this commission pool.

It is interesting that after all of the legal gymnastics, US regulators have found a circuitous way around existing legislation to enable US money managers to do exactly what UK money managers have been allowed to do through their Commission Sharing Agreements.

Click here to read the entire text of the Client Memorandum written by attorneys Larry E. Bergmann and Roger D. Blanc of Willkie Farr & Gallager, LLP.

Comment by Bill George:
So then, under this interpretation an investment advisor, or a mutual fund, can direct that a portion of its commissions be reabated back to its research department? Would this then be disclosed as a credit toward management fees? And if the advisor’s son-in-law has a great stock idea, can the advisor have his favorite broker send the son-in-law a portion of his commissions in exchange for the tip?

How do regulators and trustees propose to oversee thd explosion in this charing of institutional client’s commission dollars.

There are millions of unregistered individuals willing to produce buy /sell recommendations.


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