CFA Institute's Position on Research Payments in a post-MiFID II Era

By Gary Sarkissian posted 09-27-2019 22:04

The CFA Institute recently published a position paper that reviews the conflicts between U.S. and European rules on research payments post-MiFID II implementation and highlights the challenges that investment managers face in attempting to comply with the two regions simultaneously.  The paper—which was produced in partnership with the Healthy Markets Association and Council of Institutional Investors—summarizes its findings with recommendations to the SEC for dealing with these regulatory disparities.   
By way of background, Section 28(e), as amended in 1975, of The Securities Exchange Act of 1934 permits investment advisors to pay higher commissions on client trades in exchange for investment research without being in violation of their fiduciary duty to clients.  (That said, no stipulation was made regarding disclosure of these added costs, which the CFA Institute [formerly AIMR] later addressed with its Soft Dollar Standards in 1998.)  Furthermore, U.S. law prohibits broker/dealers from accepting cash payments for research services without registering as investment advisors, as per section 202(a)(11) of the Investment Advisors Act of 1940.  The upshot is that advisors typically compensate broker/dealers for investment research through higher trading commissions. 
Effective January 2018, the European Union’s Market in Financial Instruments Directive II (MiFID II) effected major regulatory reforms in financial markets, namely with respect to research payments.  MiFID II requires asset managers to now pay for research either with cash from the manager’s own account, or with client-funded and pre-budgeted Research Payment Accounts.  As a result, brokerage commissions became strictly transaction based.   
The new rules not only have implications for changing the current investment research and management landscape in Europe, but also pose compliance challenges for U.S.-based global money managers.  One of the pitfalls of having an uneven playing field is that research costs could potentially shift to non-MiFID II covered clients (i.e., U.S. investors).  Clients with the higher trading costs would then end up subsidizing those whose trading costs are strictly transaction related.  It is also important to note that the SEC does not explicitly prohibit paying for research out of a fund that does not directly benefit the clients of that fund. 
In 2017, in response to the petitions from organizations in the U.S. concerned with the looming changes across the Atlantic, the SEC granted a No-Action relief that permitted broker/dealers to temporarily accept cash payments for investment research without having to register as investment advisors.  That relief, however, will expire in July 2020, leaving questions as to what follows.   
To learn more, click the link below to access the report.  Reading this paper counts towards 1 hour of CE credit: 

The Future of Research in the US After MiFID II