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The BD/IA Regulator

Providing securities regulatory, enforcement and litigation trends for broker-dealers, investment advisers and investment funds

SEC Staff Solves Section 28(e)-MiFID II Compliance Conundrum—For Now

Posted in Broker-Dealer Regulation, Investment Adviser Regulation

In a series of three “no-action” letters, the staff of the Securities and Exchange Commission (SEC) published guidance to address concerns by U.S. broker-dealers and investment advisers about how to comply with Markets in Financial Instruments Directive (MiFID II) rules that limit the use of soft dollars.  Among other things, the Division of Investment Management said that broker-dealers, on a temporary basis, may receive research payments from money managers in hard dollars or through MiFID II governed research accounts from clients subject to MiFID II, without being considered to be an investment adviser.

After consulting with European regulators, the SEC staff published the guidance in response to concerns that U.S. broker-dealers that must comply with MiFID II soft dollar limitations would be forced to register as investment advisers if they provided research for hard dollars.  The long-awaited guidance provides some clarity for financial institutions faced with the dilemma of how to comply with conflicting U.S. and EU regulatory requirements.

The temporary action provides the SEC a breather to “monitor and assess” the impact of MiFID II’s requirements on the research marketplace and whether any new rules are needed.

The European Union’s (EU) recast MiFID II, which kicks in on January 3, 2018, effectively eliminates the ability of EU clients to pay broker-dealers for research services through “soft dollars.”  Section 28(e) of the Securities Exchange Act of 1934 (the “Exchange Act”) provides safe harbor for a money manager to use client commissions to purchase “brokerage and research services” without breaching its fiduciary duty.  In the U.S., money managers often use client commission arrangements to obtain brokerage and research services from a broker-dealer, using a single, “bundled” commission that is separated after execution to pay for order execution and research.  Broker-dealers can provide this research to advisers without having to register as investment advisers if the research is incidental to their brokerage business.

The Division of Investment Management also provided relief under the Investment Company Act of 1940 and the Advisers Act to permit investment advisers to continue to aggregate client orders for purchases and sales of securities, when some clients may pay different amounts for research because of MiFID II requirements, but all clients will continue to receive the same average price for the security and execution costs.  This relief allows advisers to continue to aggregate orders while addressing the differing arrangements regarding the payment for research that will be required by MiFID II.

MiFID II permits money managers to pay an executing broker-dealer for research out of a client-funded research payment account (RPA) alongside payments for order execution.

The Division of Trading and Markets said that U.S. money managers may operate within the safe harbor if they pay for research to an executing broker-dealer out of client assets alongside payments for execution through the use of an RPA that conforms to the requirements for RPAs in MiFID II, and the executing broker-dealer is legally obligated to pay for the research, provided that they meet the conditions of the Section 28(e) safe harbor.

The SEC has invited market participants to visit its website and comment on the issues.

Our Take

The long-awaited guidance from the SEC takes a practical approach that acknowledges the conundrum faced by U.S. advisers and broker-dealers that must comply with conflicting U.S. and EU requirements.  The actions solve the immediate issue while leaving open the door for future regulation once the SEC wraps its regulatory arms around how the U.S. and EU laws will work in practice and how they affect the capital markets.  Also, this approach signals that the SEC and its staff are mindful of the need for regulation while recognizing that regulations must be practical and flexible.

ThinkingCapMarkets Podcast – Replacing Familiar Benchmarks: Preparations to Phase Out the IBORs

Posted in Podcast

Long a mainstay of the financial world, the floating “IBOR” rates, based on the rates of actual or purported interbank offered loans, are now being swept slowly into the dustbin of history. The quantity, in both number and size, of existing financial products based on these floating rates is enormous, with the outstanding principal amount of such transactions globally estimated to be in the hundreds of trillions of dollars. IBORs are used extensively in numerous currencies as bases for floating rates in a wide range of transactions including derivatives, structured products, mortgages, floating rate securities and other consumer and commercial loans. A phase-out of the use of familiar benchmarks will therefore be a massive undertaking that will take many years to accomplish.

Morrison & Foerster’s Peter Green and James Schwartz discuss recent developments in relation to IBOR rates, their likely phase out, possible replacements and issues for market participants in this ThinkingCapMarkets podcast.

Our more comprehensive article on this topic can be accessed here: Replacing Familiar Benchmarks: Preparations to Phase Out the IBORs.

ThinkingCapMarkets Podcast: FINRA Communication Rules

Posted in Podcast

All communications by FINRA member firms are subject to the communications rule, which has approval and review, recordkeeping, filing and content standards.  The rule also includes exceptions from many of its requirements.  FINRA recently updated its advice relating to the use of social media by member firms, as FINRA continues to react to the rapidly changing social media landscape.  The rule covers a firm’s communications to retail and institutional investors, and many of the requirements are somewhat relaxed for institutional communications.

Morrison & Foerster’s Bradley Berman gives an overview of Rule 2210 in this ThinkingCapMarkets podcast.

Our recently updated FAQs can be accessed here: Frequently Asked Questions about the FINRA Communication Rules.

Mutual Fund Liquidity Risk Management

Posted in Events

Wednesday, October 18, 2017

Voltaire Advisors Breakfast Briefing

The New York Athletic Club
180 Central Park South
New York, NY 10019

Partner Jay Baris will participate in a panel discussion entitled “Operational & implementation Challenges for Funds & Advisers.” The expert panel will be speaking about operational challenges for fund managers.

For more information, view the full agenda, and click here to register.

Treasury Report, Part II: Regulation of the Capital Markets

Posted in Fund Regulation

The U.S. Department of the Treasury (“Treasury Department” or “Treasury”) issued its second report (of four reports), titled “A Financial System that Creates Economic Opportunities, Capital Markets” (the “Report”). The Report was issued in response to Presidential Order 137772 setting forth the Core Principles that should guide regulation of the U.S. financial system. The Report addresses various elements of the capital markets, from the equity and debt markets, to the U.S. Treasury securities market, and to derivatives and securitization. The Report also addresses the role and regulation of financial market utilities and clearinghouses. Like many movie sequels, which are somehow less compelling than the original, this second installment is less cohesive than the first Treasury report, which focused on the regulation of depositary institutions. The Report notes that certain aspects of the capital markets regulatory framework are working well, but other elements would benefit from better “calibration.” To that end, the Report recommends various measures, most of which would not require legislation, that would promote capital formation. There are few novel recommendations included in the Report. In this alert, we discuss many of the recommendations in the principal areas of interest to our clients. Read our client alert.

Morrison & Foerster’s Oliver Ireland gives a quick review of the Report in this ThinkingCapMarkets podcast.


Complimentary Teleconference – Financing Fintech: ILC Charters

Posted in Events

Thursday, October 19, 2017
5:00 p.m. – 5:45 p.m. EDT

Join us for one of our upcoming monthly telephone briefings led by members of our Fintech team.

Topics will include: What is an ILC?; What laws apply to an ILC and what laws don’t apply?; and How does it differ from an OCC Fintech Charter?

This call will be an operator-assisted call of approximately 45 minutes in duration, and will be followed by a brief Q&A opportunity. We also invite you to submit questions before the start of the call. A replay will be available upon request.

In order to RSVP for the October call, and to submit questions, please click here.

SEC Chairman Clayton Addresses Senate Committee

Posted in Broker-Dealer Regulation, Investment Adviser Regulation, SEC Enforcement

On September 26, 2017, SEC Chairman Jay Clayton delivered to the U.S. Senate Committee on Banking, Housing and Urban Affairs his first testimony as Chairman.  A copy of his prepared remarks may be found here.

Mr. Clayton’s testimony was fairly broad in scope, covering a variety of issues of concern to the Committee, from the SEC’s budget request to its activity in the enforcement arena.  However, we highlight a few items that are likely to be of particular interest to our broker-dealer clients.

Encouraging Initial Public Offerings and Investor Choice.  Mr. Clayton expressed his concern that investors could have fewer investment choices if IPOs continued their downward pace.  Accordingly, Mr. Clayton expects that regulatory tools, such as scaled disclosure and confidential submissions of draft registration statements, would continue to be used to attract smaller and mid-sized companies to the capital markets.  He indicated that the SEC will soon consider a rule proposal, as required by the FAST Act, to modernize and simplify the disclosure requirements in Regulation S-K in a manner that reduces costs and burdens on companies, while still providing for the disclosure of all required material information.

The Staff is also developing rule amendments that would eliminate redundant, overlapping, outdated or superseded disclosure requirements.  In addition, the Staff is developing recommendations for the SEC on final rule amendments to the “smaller reporting company” definition under Exchange Act Rule 12b-2, which would expand the number of issuers eligible to provide scaled disclosures.

A Fiduciary Duty for Broker-Dealers?  Mr. Clayton summarized the SEC’s current efforts and considerations in assessing changes to the standards of conduct for investment advisers and broker-dealers, including:

  • the need for retail investors to have access to high-quality and affordable investment advice, without sacrificing the protection of the securities laws;
  • the actions taken by the financial industry to date in the aftermath of the Department of Labor’s fiduciary rules, including changes to product offerings;
  • changes by mutual fund complexes to the terms of their offerings; and
  • the need to work with the Department of Labor, due to the interaction of their efforts with those of the SEC on investors and financial institutions.

Examinations of Broker-Dealers.  Mr. Clayton discussed the national examination program conducted by the SEC’s Office of Compliance Inspections and Examinations (“OCIE”).  In light of the growth of assets managed by investment advisers, the SEC has moved additional resources to these examinations; Mr. Clayton indicated that the SEC is on track to deliver a 30% increase in the number of investment-adviser examinations in 2017, or 15% of all investment advisers.

*  *  *

Mr. Clayton’s testimony reflects the fact that the SEC’s current rule making and other activities are broad in scope, are widely scrutinized, and will have a substantial impact on the financial markets.  His testimony may not have conveyed much in the way of specific actionable items for market participants, but did provide a useful overview of the types of issues that the SEC will act on during the remainder of 2017 and beyond.