Squaring The Circle:  Commission Sharing Arrangements are the best payment method for U.S. investment research following the expiry of the SEC “No Action” Letter

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In the run up to July 3, 2023, the expiry date of the SEC’s 2017 MiFID II letter recommending no action for hard cash payments for research, many people (including this writer), suggested that it would be prudent for the SEC to consider a further short-term extension to the letter. 

Simultaneously the House of Representatives Financial Services voted 45-2 to request the SEC to extend the letter by 6 months.  The pro-extension argument advocated the provision of breathing space for the asset management and investment research industry to put in place alternative solutions to enable the smooth provision of important research services to institutional investors.

The letter was not extended and expired as the SEC planned in July 2023.  Eight months on, albeit with less press coverage and discussion, problems still exist with institutional investors finding compliant methods to pay for U.S. broker-dealer investment research.  Commission Sharing Arrangements, a prominent method for paying for investment research from around the world for the last 20 years or so, can provide the solution.

Refreshing memories on the need for the “no-action” letter back in 2017, with the implementation of the MiFID II rules on payments for research, the letter allowed institutional investors to use hard cash payments to pay for U.S. broker-dealer research.  MiFiD II’s extra rules and compliance requirements around using commissions to pay for research led many of the larger European asset management companies, including the bulk of UK firms, to move to using hard cash payments for their research around the world.  The letter therefore facilitated UK asset managers to make hard cash payments to U.S. broker-dealers for their research.  Such hard cash payments, if accepted by U.S. broker-dealers would have required those broker-dealers to register as investment advisers, a lengthy process many broker-dealers were unwilling to go through.

The “no-action” letter allowed European asset management companies to “square the circle” between the conflicting aspects of European regulations and U.S. regulations in this area.  Since its expiry, UK and EU-based asset management companies and U.S. broker-dealers have been required to find alternative approaches to paying for research services.  Payment via non-U.S. offices of U.S. broker-dealers have been utilised but it is not clear whether these will be permitted going forward.

On the other hand, the SEC has made it clear (through remarks at PLS: Investment Management 2002, July 26, 2002 by William Birdthistle) that CSAs would continue to be an acceptable form of payment for U.S. broker-research, even following the expiry of the no-action letter, and regardless of whether the broker-dealer is registered as an investment adviser.

It was further confirmed in conversations I had with SEC staff in early summer 2023, that the separate October 2017 SEC letter to the Asset Management Group of SIFMA would remain in effect, meaning that Research Payment Accounts (RPAs) funded by Commission Sharing Arrangements would continue to be an acceptable means of payment, although RPAs funded by direct charge (from the assets under management) or payments from asset management company funds (“P&L”) would not.

Elsewhere and as I write with the UK’s Financial Conduct Authority releasing their Consultation Paper on new optionality for research payments on April 10, 2024, their suggested “New Bundled Payments” option bears more than a few resemblances to CSAs, so we can anticipate some very welcome further narrowing of the gaps in rules and practices between the various regulatory regimes around the world.

CSAs are simple to implement, straightforward to administer and provide a transparent and compliant way to pay for best-of-breed research from anywhere, as well, it should be said, assisting with an asset management company’s need to satisfy “best execution” requirements.

In an age of complication, CSAs – or as I call their proper implementation – “Full CSAs”, offer a refreshingly simple way of solving regulatory conundrums and bringing harmony to the procurement of investment research.

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About Author

Mike Mayhew is one of the leading experts on the investment research industry. In addition to founding Integrity Research, Mike is on the board of directors of Investorside Research Association, the non-profit trade association for the independent research industry, and a frequent speaker on research industry trends and developments. Mike has over thirty years of research industry experience. Email: Michael.Mayhew@integrity-research.com

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