SEC staff pull the rug out from under ‘hard dollar’ research deals – Publications
July 27, 2022
Staff at the U.S. Securities and Exchange Commission division of Investment Management have announced that they will allow their October 26, 2017 no-action letter to SIFMA to expire on July 23, 2023, raising questions about the possible investment adviser status of broker-dealers who, after this date, accept payments in cash or “hard dollars” for the search of investment managers subject to the EU Markets in Financial Instruments Directive II.
In the 2017 no-action letter to SIFMA (SIFMA Letter), Securities and Exchange Commission (SEC) staff said they would not recommend enforcement action if a broker accepted cash payments for researching an investment manager, which was required by the guideline II on markets in financial instruments (MiFID II) to pay for research with its own money rather than with clients’ commissions (or “soft dollars”). The announcement threatens to upend research agreements between brokers and investment managers (especially global investment managers) that have been structured to comply with MiFID II.
In a July 26, 2022 speech, William Birdthistle (Director, Investment Management Division) stated that “The Division anticipates that the temporary position will expire on July 3, 2023 and does not anticipate issuing any further assurances regarding the status advising broker-dealers accepting clearing under MiFID II agreements. He attributed this position to “developments in the research services market”, noting that “companies have developed a variety of solutions to deal with the impact of MiFID II”. The only solutions he alluded to were moves by brokers to bundle some aspects of their research business into an investment advisory business, saying: “[s]Some brokers are dual registered investment advisers and others use a registered affiliate adviser to provide certain research services.
However, this practice has been limited in the market, with many (if not most) brokers still accepting cash or “hard dollar” payments for research under the SIFMA No Action Letter. Indeed, the SEC’s February 18, 2022 report to Congress, Staff Report on the Issues Affecting the Provision of and Reliance Upon Investment Research Into Small Issuers, identified five broker-dealers who had “registered their research departments as investment to allow any asset manager to use money to pay for their investment research.
When SEC staff extended the expiration date of the SIFMA letter to November 4, 2019, SEC staff said that “business practices regarding payments for research, including in response to MiFID II requirements, continue to evolve, but various challenges remain.” It is by no means clear that these business practices have become more sedentary than they were in 2019 or that the challenges have dissipated in such a way as to render the SIFMA letter useless.
Importantly, SEC staff made it clear in the July 26 statement that the expiration of the SIFMA letter does not affect “statements or positions of SEC staff that are independent of temporary adviser status.” , such as those relating to client commission arrangements”. This refers to comments on client commission agreements (CCAs) made by SEC staff in the 2019 extension, in footnote 8, stating that:
Further, we understand that under CCAs, … the fund manager in some cases (a) may not have a business relationship with a broker who receives research commissions from the CCA or (b) to the extent that if it has a business relationship with such broker-dealer, transactions may not be related to the search for such broker-dealer. We further understand that some brokers have questioned whether accepting commissions from clients to pay for research in these circumstances would affect the availability of the exclusion for brokers from the definition of “investment adviser” in under the Counselors Act. In this regard, the staffs believe that the Commission was aware of these types of PADs when it issued its 2006 interpretation and did not question the availability of the dealer exclusion in the context of these types of CCA. See Commission Guidance Regarding Client Commission Practices Under Section 28(e) of the Securities Exchange Act of 1934, Exchange Act Release No. 54165 (July 18, 2006), 71 Fed. Reg. 41978 (July 24, 2006). Therefore, staff is of the view that the use of these PADs does not affect whether the broker exclusion may be available in relation to the receipt of payments for research under section 28(e) .
This clarification is significant if it gives brokers leeway in the event of the expiry of the SIFMA letter to restructure existing hard dollar arrangements put in place based on the SIFMA letter.
More broadly though, the Investment Management Division’s signal of next year’s expiration of the SIFMA letter signals the very concerns that prompted SEC staff to release that letter in the first place, as summarized in the February 18, 2022 SEC report to Congress. , “US brokers have expressed concern that if they receive ‘hard dollars’ for their research, these fees could subject the broker to regulation under the Advisers Act. In turn, US fund managers have raised concerns that if a US broker is unwilling or unable to accept separate payments for research (i.e. payments that are not bundled with commission payments for order execution), fund managers may not be able to obtain the research that would benefit their advised accounts.
In his speech announcing the SEC staff’s decision to allow the SIFMA letter to expire next year, Birdthistle made it clear that the SEC staff is making its “intentions known well in advance of July 2023 to allow sufficient time to resolve any particular issues” and encouraged “the public to engage” with SEC staff “on any particular issues relating to MiFID II, including any concerns related to the expiration of the temporary no-action position.”
SEC staff’s announcement that it intends to allow the SIFMA letter to expire next July does not appear to affect other SEC staff no-action letters designed to address inconsistencies between U.S. law and MiFID II, including no-action letters from SEC staff.
If you have any questions or would like more information about the issues discussed in this LawFlash, please contact any of the following Morgan Lewis attorneys:
Amy Natterson Kroll
Ignacio A. Sandoval
Steven W. Stone
Timothy W. Levin
 SIFMA, SEC Staff No-Action Letter (October 26, 2017).
 Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Directive 2002/92/EC and Directive 2011/61/EU, as implemented by the Member States of the European Union.
 William Birdthistle, Remarks at PLI: Investment Management 2022 (July 26, 2022).
 See SEC, Staff Report on the Issues Affecting the Provision of and Reliance Upon Investment Research Into Small Issuers (February 18, 2022) at 29 n. 118 (quoting Michael Mayhew, Integrity Research Associates, Can Asset Managers Not Subject to MiFID II Use Cash to Pay for US Research?, January 27, 2020) (Congress Report 2022). The SEC report was required by Section 106 of the Consolidated Credits Act of 2021.
 SIFMA, SEC Staff No-Action Letter (November 4, 2019).
 Congress report 2022 at 34.