Recently, Harvard Law School Professor, Howell E. Jackson and CEO of Healthy Markets Association, Tyler Gellasch published an article arguing that “if the SEC [extends its “no action” letter], public pension plans, endowments, and millions of Americans invested in mutual funds will lose out.”
Equal Treatment for U.S. Investors
In a set of prepared remarks made on July of 2022, William Birdthistle the SEC Director, Division of Investment Management explained that the SEC does not intend to extend its temporary “no action” letter regarding payment for investment research under MiFID II that is due to expire on July 3, 2023.
These comments came in response to a No-Action letter to SIFMA written on October 26, 2017 indicating that the SEC would not take enforcement action against a broker-dealer who receives cash payments for the provision of their investment research from an asset manager who is subject to MiFID II. The SEC extended this temporary “No Action” relief on November 4, 2019.
In a recent article called Equal Treatment for U.S. Investors published in the Harvard Law School Forum on Corporate Governance by Howell E. Jackson and Tyler Gellasch, the authors argued that “…public pension plans, endowments, and millions of Americans invested in mutual funds will lose out” if the SEC succumbs to industry pressure and decides to extend this “no action” letter once again.
Messrs. Jackson and Gellasch argue that the SEC’s “No Action” letter, which was limited only to firms subject to MiFID II, did not allow broker-dealers to accept cash payments from the majority of U.S. investors. The authors explain the problems this causes for U.S. investors, including:
“Beyond being patently unfair to U.S. investors, the SEC no-action relief causes three distinct problems. First, it distorts best execution practices because it allows securities firms to force investors to accept inferior execution quality in order to obtain critical research. Second, it encourages asset managers to opt for bundled commissions and thereby to push operating costs onto less sophisticated investors (often, mutual fund investors) without any meaningful disclosures. Third, it runs a serious risk that U.S. investors will end up subsidizing European clients working with global asset managers, who may use U.S. bundled commissions to pay for research costs that then support investments made on behalf of European clients who do not bear a similar charge.”
Jackson and Gellasch conclude that the SEC should withstand industry pressure and allow the “No Action” letter to expire. This they argue would force both U.S. clients and MiFID II clients to work with brokers to find out a way to pay cash for sell-side research. The authors mention some existing models that might work for both US and EU investors including having their brokers register as investment advisors or adopting the reimbursed CSA model currently used by MFS.
Our Take
The recent article published by Messrs. Jackson and Gellasch on the SEC’s “No Action” letter is clearly a response to concerns that investment banks and broker-dealers will try to pressure the SEC into extending it once again – an act that they believe would disadvantage U.S. investors who cannot pay for sell-side research with cash today.
We don’t disagree that U.S. investors who want to pay for research with cash today don’t have the same flexibility that their MiFID II cousins do. However, it is unclear that many U.S. investors find this to be a real issue. After speaking with dozens of institutional investors, we have discovered very few who want to go down this road. In fact, today any U.S. investor could adopt the reimbursed CSA model used by MFS if they truly wanted to unbundle their trading activity from their research payments. The fact that this has not taken place provides clear evidence that most U.S. investors are happy with the status quo.
What is obvious from this article is that Jackson and Gellasch disapprove of “soft dollars” and are disappointed that the SEC didn’t follow ESMA and the FCA when they first adopted the research unbundling rules promoted by MiFID II. In addition, the authors believe the SEC only made a bad situation worse by giving MiFID II investors this temporary “No Action” relief that wasn’t also offered to U.S. investors.