On October 26, the SEC staff provided, in three related no-action letters, a 30-month grace period during which it will not pursue enforcement actions against U.S. broker-dealers and their client money managers subject to European Union regulations, including investment advisers, for accepting or making direct and separate (i.e., hard dollar) payments for research. This grace period temporarily relieves a regulatory conflict concerning how market participants provide and pay for research between current U.S. securities laws and the European Union’s new Markets in Finance Instruments Directive (MiFID II) rules, which will take effect on January 3, 2018.
The MiFID II rules require money managers to separately pay for research, instead of using commission payments to also pay for research provided by a broker-dealer or a third-party research provider, as is the practice in the U.S. Under U.S. securities laws, a U.S. broker-dealer that receives separate compensation for research may be required to register as an investment adviser because such compensation would not be “solely incidental” to its brokerage services. The recent SEC no-action letters have clarified, however, that broker-dealers may temporarily receive research payments from money managers that are subject to MiFID II’s requirements in hard dollars without being required to register as an investment adviser. In addition, the SEC staff will not recommend enforcement action against a money manager who, relying on the safe harbor in Section 28(e) of the Securities Exchange Act of 1934, pays for research through the use of a research payment account, which is a client-funded account dedicated to making research payments. The letters also state that money managers may continue to aggregate orders for mutual funds and other clients and rely on an existing safe harbor allowing for soft dollar research payments when paying broker-dealers for research and brokerage.
Notably, the SEC’s announcement reflects cooperation with the European Commission. In response to the no-action letters, Valdis Dombrovskis, the European Commission’s vice president for capital markets, commented that it “welcome[s] the decision of the staff of the U.S. Securities and Exchange Commission to simultaneously agree to relief for U.S. brokers supplying research to EU firms.”
Along with the 30-month grace period, the SEC intends to monitor the impact of the MiFID II rules and encourage public comment on what action the agency should take next. SEC chairman Jay Clayton explained the SEC’s position is formulated to “prevent confusion and operational difficulties” and “should preserve investor access to research in the near term.” This grace period provides U.S. brokers and the SEC time to assess how to best respond to this regulatory conflict in a way that assures U.S. brokers will be able to provide research to EU clients in the future.
Securities firms should be mindful that the relief is not permanent, and the SEC may determine not to extend the relief after its expiration in July 2020. As a result, the registration and fiduciary obligation implications of MiFID II’s unbundling requirements may still impact U.S. securities market participants. However, this relief provides a welcome period for firms to strategically assess their operations and business relationships and, if necessary, make any modifications they deem necessary or advisable in an orderly manner. In this regard we note reports from the Financial Times that Bank of America Merrill Lynch has already filed to register as an investment adviser in response to MiFID II’s implementation, which will allow it to receive MiFID II compliant unbundled research payments.