On October 26, 2017, the SEC issued three critical no-action letters all in response to the upcoming MiFID II compliance date of January 3, 2018. Under MiFID II and its related Delegated Directive, firms will no longer be allowed to bundle research payments with execution costs (soft dollars) unless specific MiFID II Research Payment Accounts (“RPA”) are utilized that separate the two costs for tracking and compliance purposes.
This European Commission directive has raised concerns for US broker-dealers, investment advisers, and mutual fund companies that utilize soft dollar arrangements under Section 28(e) of the Exchange Act. The current US practice of bundling research and execution payments under one cost to the client will run afoul of MiFID II provisions for any European clients of US firms.
To address this conflict between MiFID II and Section 28(e), the SEC issued three no-action letters, summarized here:
1. SIFMA SEC No-Action letter, dated October 26, 2017 (Section 28(e)). This letter focuses on Section 28(e) and the direct conflicts with MiFID II. Here, the Division of Trading and Markets allows for the continued use of soft dollar payments under the following circumstances:
a. Money managers make payments to executing brokers with client dollars for research alongside payments to brokers for execution services (traditional soft dollars);
b. Research services must fall under those products and services that are eligible for the Section 28(e) safe harbor;
c. Securities transactions executed by the broker are for Section 28(e) purposes; and
d. The executing broker must be contractually obligated to pay for research via an RPA account in connection with the money manager’s Client Commission Agreement (“CCA”).
Item 1d above will now require soft dollar arrangements to be documented with a contract, whereas, currently many exist on an informal basis unless with a soft dollar aggregating firm.
2. SIFMA SEC No-Action letter, dated October 26, 2017 (Section 202(a)(11)). The letter provides relief for broker-dealers under the Advisers Act registration rule since the unbundling of commissions would deem the receipt of research payments as payment for investment advice under Section 202(a)(11) of the Advisers Act. This relief is granted for 30 months from the MiFID II effective date or approximately June 1, 2020.
3. ICI SEC No-Action letter, dated October 26, 2017 (Rule 17d-1). This letter expands upon the SMC Capital no-action letter regarding the aggregation of orders, which allows for brokerage transactions to be aggregated together as one batch trade via an omnibus account, if the transactions are executed at an average price for all accounts and securities are allocated fairly across participating accounts. The new relief applies this same methodology to research payments. To obtain the relief, advisers must adopt written policies and procedures that:
a. Ensure each client in an aggregated order pays the same average price and same cost of execution on a rate basis;
b. Research payments are consistent with regulatory requirements (by jurisdiction) and disclosed to clients; and
c. Trade allocations will conform to written allocation procedures.
Importantly, the above no-action letters only apply for firms affected by MiFID II. A US only firm (no European presence or clients) cannot rely upon these relief letters.