A recent article in response to our blog post, The SEC Should Take Immediate Action to Preserve Critical Research Under MiFID II, contains inaccurate information about banks’ research practices and makes flawed arguments and recommendations that, in connection with the expiration of the MiFID II no-action relief, would negatively impact the market for investment research.

A quick refresher: the U.S. Securities and Exchange Commission provided critical relief that allows U.S. brokers to accept unbundled payments for research from investment managers who are required under MiFID II to make such payments in unbundled form. Our members continue to have significant concerns with the expiration of the relief, currently slated for July 3, 2023, and strongly believe the SEC should extend it to avoid unnecessary market disruptions.

There are several key thematic flaws and inaccuracies in the article:

• Misguided focus on broader policy debate about unbundling and soft dollars. The Article advocates for the expiration of the MiFID II Letter based on a belief that expiration of the letter will lead to broader adoption of unbundled payments for research in the U.S. The authors of the Article have been vocal opponents of bundled payments for research and trade execution (e., soft dollars) for a long time, and use the upcoming expiration of the letter as another opportunity to advocate for the elimination of soft dollars. In doing so, the Article completely overlooks legitimate concerns about brokers having to cut off access to research services when the MiFID II Letter expires because they are unable to accept unbundled payments from MiFID II managers who are required to make unbundled payments under MiFID II.
  • The Article claims that MiFID II had no significant impact on research coverage, quality or volume. This claim is inconsistent with recent policy discussions in Europe and the UK, where consideration is being given to rolling back aspects of MiFID II because of misgivings about the law’s effects.^[1] But in any case, the impact of MiFID II on research availability is separate from the impact of the expiration of the MiFID II letter.

 

• Disregard for the consequences on capital formation, market efficiency and competitiveness. There is a significant risk that investment managers will lose access to important research services when the MiFID II letter expires because brokers will be unable to accept unbundled payments for research. The Article overlooks this risk by claiming that brokers can simply accept unbundled payments for research by moving their research business to an investment adviser, but that is a gross oversimplification, as discussed in more detail in our original blog post and below. Therefore, there is a legitimate risk that many brokers will have to limit the research services that they provide to some clients, and we are very concerned that such a disruption to the supply of research services could negatively impact capital formation and market efficiency. We are also concerned that the expiration of the letter will negatively impact the competitiveness of U.S. markets and research providers, as European brokers are not subject to similar restrictions on their ability to accept unbundled payments for research. Notably, the SEC’s Small Business Capital Formation Advisory Committee, which is comprised of independent persons selected by the SEC, unanimously recommended the extension of the letter because of concerns about disruptions to the research market.^[2]

 

• No acknowledgment of the conflicts between U.S. law and MiFID II. The fundamental dilemma created by MiFID II is that MiFID II requires unbundled payments for research, while the Investment Advisers Act of 1940 (Advisers Act) provides that a broker can be regulated as an investment adviser if they receive unbundled payments for research that constitutes investment advice. SIFMA’s members have dedicated significant time and resources towards finding ways to restructure their businesses to address the regulatory conflicts created by MiFID II, including moving research services to an investment adviser, but the Advisers Act poses intractable conflicts with many firms’ business models. These conflicts, which we discussed in detail in our previous blog post and which the Article did not acknowledge or address, include (i) disclosure and consent requirements for principal trades that are not feasible for high speed and fluid trading and (ii) fiduciary requirements that are incompatible with the arms-length relationship between brokers and their research clients. While some firms have moved some of their MiFID II-defined research services to an investment adviser, many of those firms continue to provide other MiFID II-defined research services through their broker and are at risk of terminating those services for some clients if the relief in the MiFID II Letter expires. Many other firms are unable to move any of their research services to an investment adviser and will be unable to receive unbundled payments for research. In short, there is no easy solution to the conflicts between U.S. law and MiFID II.

 

• Inaccurate information about research practices and soft dollars. SIFMA believes that a debate over the expiration of the MiFID II Letter is not the proper forum for debating the policy merits of soft dollars, but there are number of inaccuracies in the Article about research practices and soft dollars that nevertheless need to be corrected, a few of which we address below:
  • Execution costs. Investment managers cannot “accept substandard execution services” because they are paying for trades in soft dollars. Investment managers have a duty to achieve best execution on behalf of their clients, and that obligation is not altered when they pay for trades in soft dollars. Further, per trade charges for research of 5 to 10 cents per share are non-existent based on data from our members. According to that data, research charges average 1 to 1.5 cents per share.
  • Choice of brokers. Investment managers are not required to execute trades with, and potentially accept substandard execution (an allegation in the Article) from, the brokers they purchase research from. Investment managers commonly use pooling arrangements – like commission sharing agreements (CSAs) – that allow them to pay bundled commissions for trades that they execute with one broker, and use the research credits from those trade to purchase research from another broker.
  • Separation of research and execution costs. The article focuses on the impact that MiFID II has had on asset managers’ being better able to separately shop for research and trading services, but this omits the fact that European asset managers have long used CSAs prior to MiFID II to separate research and execution spending.
  • Soft dollar abuses. The Article points to inappropriate use of soft dollars for things like office renovations and trips to the Caribbean. While there were isolated incidences of this conduct over twenty years ago, there are now clear guidelines from the SEC prohibiting such conduct^[3] that are strictly enforced, and such abuses are rare to non-existent today. Isolated instances of illegality from many years ago are not valid arguments against regulated and legal uses of soft dollars.

It also is worth noting that soft dollars have long been permitted in the United States, with the practice being codified in 1975 in Section 28(e) of the Securities Exchange Act of 1934. While we recognize that policy debates on the MiFID II unbundling requirement have occurred in Europe, no such formal debates have occurred here in the U.S. since the adoption of this MiFID II requirement. The SEC has considered soft dollar practices a number of times before MiFID II, and has consistently chosen stricter oversight of soft dollars practices rather than prohibition. The question of whether unbundling should be mandated in the U.S. is a policy debate that ultimately would need to be addressed through legislative changes, and that unfinished policy debate should not affect decision-making about the expiration of the MiFID II Letter, which poses distinct risks to the research market.

Given these flaws and inaccuracies, we believe it is appropriate to set the record straight. We continue to maintain our view that immediate action via an extension of the no-action letter is needed and warranted to help prevent significant disruption to the market for investment research.

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

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^[1]See (https://www.shearman.com/en/perspectives/2023/03/mifid-ii–an-update-on-the-rules-for-unbundling-of-research).

^[2]See Small Business Capital Formation Advisory Committee, Letter to the Honorable Gary Gensler (Feb. 28, 2023), available at https://www.sec.gov/files/public-company-research-recommendations-022823.pdf.

^[3]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), available at https://www.sec.gov/rules/interp/2006/34-54165.pdf. 

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  The SEC Should Take Immediate Action to Preserve Critical Research Under MiFID II