European regulations on soft dollar commission and investment research adopted as part of MiFID II are changing practices in the US.
Overview and Recommended Requirements for Investment Managers and Advisers
This paper:
- explores the history of research payment rules in the United States,
- outlines the global changes in research procurement and payment practices,
- explains why these changes are happening now, and
- offers regulatory recommendations to address these changes.
CFA Institute, together with the Healthy Markets Association (Healthy Markets) and the Council of Institutional Investors (collectively, the Coalition), conveyed two recommendations to Jay Clayton, Chair of the US Securities and Exchange Commission (Commission or SEC) to address issues raised by the Markets in Financial Instruments Directive II (MiFID II) for US-based broker/dealers and asset managers. The Coalition recommended that the SEC revise guidance under Section 28(e) of the Securities Exchange Act of 1934 (the Exchange Act) as follows:
- require investment managers and advisers who seek to rely on the Section 28(e) safe harbor to disclose amounts paid for research from client assets; and
- require investment managers and advisers who seek to rely on the Section 28(e) safe harbor to adopt and implement procedures to ensure benefits of research go to the asset owners who pay for it.
Our Position
Recommended Regulatory and Industry Response
To address the conflicts and changes MiFID II has created for US-based broker/dealers and asset managers, we recommend the following regulatory and industry responses:
- the SEC should interpret Section 202(a)(11) to permit broker/dealers to accept cash as payment for investment research without having to register as investment advisers;
- the SEC should require asset managers to disclose to their asset-owner clients the cost of research purchased on their behalf through Client Brokerage arrangements;
- asset managers should adopt policies and procedures to ensure that the research purchased from Client Brokerage arrangements, over time, benefits the asset owners whose trading commissions paid for the research;
- asset managers should adopt and implement policies and procedures that move toward separating research procurement decisions from decisions about with whom and how to trade;
- the SEC should consider investor outcomes rather than specific costs, when interpreting whether an investment manager or adviser is achieving best execution for its clients; and
- the SEC should revise its interpretations of Section 28(e) and such other rules and guidance as is necessary and appropriate to effectuate these recommended reforms.
Main Points
Sophisticated asset owners, for example, have long called for disclosure of research costs paid through Client Brokerage, but with little success. Sensing the change in competitive balance from MiFID II, however, US asset owners are not only demanding disclosure of how their hired asset managers are using Client Brokerage, but in some cases demanding they not be asked to pay for research at all. Globally, too, asset managers are adjusting what they will pay for broker research as part of their broker selection and trading decisions. At the other end of the spectrum, many research providers are struggling to adapt to increased price transparency and increased scrutiny of research and trading costs.
Although ostensibly applicable only to investment firms in the 28 EU member states, MiFID II has created important and foundational changes in the global research market. That conflict ultimately required the no-action relief for brokers and asset managers that is the concern of this report.