SEC Provides Temporary Relief from MiFID II Research Requirements
Advisers and broker-dealers can relax – at least a bit. In a trio of no-action letters issued October 26, the SEC assured them that they will not take enforcement actions against them if they fail to meet certain European Union requirements regarding research dollars and more that take effect January 3.
The letters, in a nutshell, create time for asset managers, broker-dealers and the SEC to adjust to certain requirements under the EU’s Markets in Financial Instruments Directive (MiFID II). Those requirements relate to how research dollars are grouped and spent in European countries.
The MiFID II, a broad revision of European Union financial law, has got much of the domestic asset management industry astir, particularly given the amount of business domestic firms do in EU countries. Advisory firms, broker-dealers and their attorneys need to find ways to meet these requirements while at the same time staying in compliance with domestic laws and regulations, including those from the SEC, which itself needs time to adapt.
The financing of research is a case in point. Under U.S. regulations, advisers can pay broker-dealers in soft dollars for research under an Exchange Act safe harbor. MiFID II, however, generally requires that advisers separate brokerage and execution costs. This means that advisers must pay broker-dealers for research in hard dollars from their own resources, or from special compliant research accounts, rather than paying soft dollars that are part of brokerage commissions, said Morrison and Foerster partner Jay Baris. "That would mean those broker-dealers would have to register as advisory firms," he said, something many broker-dealers do not want to do.
One of the no-action letters provides 30 months relief from this requirement by permitting domestic broker-dealers to receive hard dollar payments from advisers without themselves having to become advisers.
"The entire domestic asset management industry is in a mad dash to comply with MiFID II," said Morgan Lewis partner Timothy Levin. "The no-action letters are absolutely critical to allay the concerns of both the buy and sell sides in the asset management business in regard to complying with both the U.S. and MiFID II requirements."
"It is a good thing and absolutely needed," said Sidley Austin London-based partner Leonard Ng. "Without this, U.S. broker-dealers would have lost a lot of European investment manager business."
The no-action letters
Following is a summary of the three letters and what they do:
Paying for research. This is the no-action letter providing the 30 months relief referenced above. "The Division of Investment Management provided temporary relief for thirty (30) months from MiFID’s implementation date under the Investment Advisers Act of 1940 to permit a broker-dealer to receive payments in hard dollars or through MiFID-governed research payment accounts from MiFID-affected clients without being considered an investment adviser," the SEC said in its announcement of this no-action letter. The Securities Industry and Financial Markets Association (SIFMA) requested the letter. Thirty months is an appropriate amount of time, said Levin, given not only the legislative changes that will be needed to comply with this MiFID II requirement, but the time businesses will need to acquire and adapt technology to comply.
Aggregation of client orders. With this no-action letter, issued in response to a request from the Investment Company Institute, the SEC staff will "permit investment advisers to continue to aggregate client orders for purchases and sales of securities, where some clients may pay different amounts for research because of MiFID II requirements, but all clients will continue to receive the same average price for the security and execution costs," the agency said in its announcement. The concern here was that domestic advisers typically can aggregate trades only if clients receive an average price and share execution costs pro rata, Baris said. Without this guidance, advisers might not be able to aggregate trades of domestic clients and clients regulated by MiFID II, he said.
Paying for brokerage and research services. With this no-action letter, sent in response to a request from SIFMA’s asset management group, the agency’s Division of Trading and Markets said it would "allow money managers to operate within the [soft dollar] safe harbor if the money manager makes payments for research to an executing broker-dealer out of client assets alongside payments for execution through the use of a research payment account (RPA) that conforms to the requirements for RPAs in MiFID II." The executing broker would be legally obligated to pay for the research.
The SEC consulted with the EU prior to issuing the letters, the agency said.
"Today’s no-action relief was designed with input from a range of market participants to reduce confusion and operational difficulties that might arise in the transition to MiFID II’s research provisions," said Clayton. "Staff’s letters take a measured approach in an area where the EU has mandated a change in the scope of accepted practice, and accommodates that change without substantially altering the U.S. regulatory approach."
"These steps should preserve investor access to research in the near term, during which the Commission can assess the need for further action," he continued. During the temporary relief period, agency staff will monitor and assess the impact of MIFID II’s research provisions on the research marketplace and those affected "in order to determine whether more tailored or different action, including rulemaking, is necessary and appropriate in the public interest," the agency said.
Commissioner Kara Stein, however, saw things a bit differently. MiFID II was designed to give investors transparency into the cost of both research and trading commissions by requiring that payments be unbundled, she said in a statement, and the no-action relief simply postpones matters without resolving them.
"Questions about transparency and investor protection are central to this conflict," she said. "When payments for research and trading are combined, do investors know that they are paying for research? Do investors know what they are paying for trading? Do investors know of the potential conflicts of bundled payments?"
"The staff’s no-action relief does not adequately address these issues and merely kicks the can down the road," Stein said. "This inaction may be costly to investors and advantage some market participants over others. While a time-limited approach may allow the staff to study the impact of MiFID II, taking over 900 days is simply unreasonable."
She urged the SEC staff and the Commission to "consider timely notice and comment rulemaking in order to reach the best policy outcome in this area."