MiFID II and Transactional RPAs: SEC Staff Provides Informal Guidance

Under the European Union’s Markets in Financial Instruments Directive II (MiFID II), the research that investment managers typically receive from broker-dealers is generally classified as a prohibited “inducement” unless the investment manager pays for the research either: (a) directly from its own resources; (b) from a Research Payment Account (RPA) funded, with the client’s prior approval, with a client’s money; or (c) a combination of the two methods.

In connection with MiFID II coming into force in 2018, staff of the SEC’s Division of Trading and Markets issued a no-action letter to SIFMA AMG, dated October 17, 2017, that confirmed that RPAs established under MiFID II and structured like client commission arrangements (CCAs) in the U.S. were eligible for the soft dollar safe harbor under Section 28(e) of the Securities Exchange Act of 1934. CCAs have long been used in the U.S. to allow investment managers to execute trades with one broker-dealer and use the commission paid for those trade executions to pay for research produced by another broker-dealer. In 2006, the SEC confirmed that CCAs are permissible and qualify for the Section 28(e) safe harbor. However, since the SEC staff issued the SIFMA AMG no-action letter in 2017, questions have arisen as to whether payments for broker-dealer research from so-called transactional RPAs could cause the broker-dealers to not qualify for the broker exception from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940.

In response, the staff SEC’s Division of Investment Management has advised SIFMA that payments from so-called transactional RPAs funded alongside commissions need not be treated as “special compensation” for purposes of the broker exception from the definition of investment adviser in Section 202(a)(11) of the Advisers Act. Specifically, they advised that a lawyer could reach the reasonable view that payments from RPAs that are structured like client commission arrangements described in the SIFMA AMG no-action letter would not raise special compensation or related investment adviser status issues under the Advisers Act for broker-dealers that receive such payments for research.

The SIFMA AMG no-action letter only covers circumstances where:

• The money manager makes payments to the executing broker-dealer out of client assets for research alongside payments to that executing broker-dealer for execution.
• The research payments are for research services that are eligible for the safe harbor under Section 28(e).
• The executing broker-dealer effects the securities transaction for purposes of Section 28(e).
• The executing broker-dealer is legally obligated by contract with the money manager to pay for research through the use of an RPA in connection with a CCA.

For detail, see page 3 of the no-action letter.

—

Joe Corcoran is Managing Director and Associate General Counsel in SIFMA’s Capital Markets Group.