Unless you attended the PLI Investment Management 2022 program on July 26, 2022, you may have missed an important announcement made by the US Securities and Exchange Commission (SEC) Division of Investment Management’s Director, William Birdthistle. In his speech, Director Birdthistle announced that SEC staff relief granted to broker-dealers in 2017, extended in 2019,1 from registration under the US Investment Advisers Act of 1940 (“Advisers Act”) to the extent they receive payments from asset managers or research payment accounts as compensation for research would not be extended beyond its current expiration date in July 2023.
The 2017 relief was granted in anticipation of the effectiveness of MiFID II,2 which in essence imposes substantial restrictions on EU investment firms in using soft dollars (or client commissions paid to brokers for order execution) to pay for research. The MiFID II restrictions apply to investment firms that provide portfolio management services to clients in EU states, including sub-advisers. The SEC staff relief has allowed money managers to aggregate or bunch orders for clients while accommodating different compensation and related arrangements. MiFID II and the SEC staff letters have had an impact on US SEC-registered investment advisers that have clients in the EU, among other locations, including the United States, in terms of how research can continue to be paid for in soft dollars. And, just as importantly, these letters have allowed broker-dealers to continue to receive payments for research in a MiFID II-compliant manner without being deemed to be investment advisers. Since MiFID II took hold, research compensation has been in the form of payments that are not classic commissions and could be viewed as “special compensation,” which a broker-dealer cannot receive if it relies on the statutory exclusion from the definition of “investment adviser” under the Advisers Act. The no-action letters have permitted broker-dealers to continue to provide research and receive this form of payment while remaining within the broker-dealer exclusion from the definition of investment adviser.
Advisers Act Section 202(a)(11) defines an investment adviser, in relevant part, as one who engages in the business of advising others, either directly or through publications or writings, as to the value of securities. Subsection (C) of that definition excludes broker-dealers who provide investment advice on a “solely incidental basis” and for “no special compensation.” With the advent of MiFID II, concerns were raised that “unbundled” payments for research, that is, direct payments instead of soft dollars derived from commission payments, while consistent with MiFID II, would constitute special compensation under the Advisers Act and subject broker-dealers to investment adviser regulation and registration. The 2017 relief, as extended in 2019, provided that, on a temporary basis, broker-dealers receiving separate research payments from asset managers or from research payment accounts as a consequence of MiFID II would not be deemed investment advisers under Advisers Act Section 202(a)(11). As noted by Director Birdthistle, this relief was temporary to allow the SEC to learn and understand how the industry was adjusting to MiFID II. In his words, “And we understand that firms have developed a variety of solutions to address the impact of MiFID II: Some broker-dealers have dually registered as investment advisers and others utilize a registered adviser affiliate to provide certain research services.” The least common denominator of those “solutions” appears to be that research will have to be provided by an investment adviser come July 2023. But, according to Director Birdthistle, “[w]e are making our intentions known well in advance of July 2023 to allow ample time to address any particular issue.”
To the contrary, substantial time, resources, and steps will likely be necessary to overlay investment adviser registration and regulation on broker-dealer research operations that have been deliberately designed with information barriers and other measures to ensure the integrity of the research or to otherwise register an affiliated entity as an investment adviser. This announcement, along with the recent Request for Comments concerning the status of information providers as “investment advisers” under the Advisers Act,3 collectively might be viewed as proactive steps by the SEC to bring broker-dealers into the investment adviser fiduciary mold where Regulation BI stopped short of doing so. Although proposed legislation seeks to provide relief from investment adviser status for broker-dealers that receive such compensation for research, that legislation is unlikely to proceed in the current Congressional session.4