On October 26, 2017, the staff of the SEC, following consultation with European authorities, issued three no-action letters to provide guidance to market participants seeking to comply with the requirements of the European Union’s (EU) Markets in Financial Instruments Directive II (MiFID II) that take effect on January 3, 2018.  

MiFID II will, among other things, generally prohibit certain investment advisers from receiving or retaining “inducements” from a third party—such as commissions, fees or other monetary or non-monetary benefits, including, importantly, certain research from an executing broker-dealer—in connection with providing any investment or ancillary service to a client. Under MiFID II, an investment adviser can continue to receive research without violating the inducement prohibition if the investment adviser pays for that research (1) directly (i.e., out of the investment adviser’s own resources); (2) with client approval, from a separate research payment account (RPA) controlled by the adviser, funded with client assets and subject to a research budget that is regularly assessed and agreed upon with the client; or (3) through a combination of (1) and (2). The practical effect of the foregoing is the required separation of bundled commission payments for research and brokerage services made by investment advisers subject to MiFID, either directly or by contractual obligation.¹

Subject to various terms and conditions, the three no-action letters essentially provide that: (1) broker-dealers, for 30 months from MiFID II’s implementation date, may receive separate payments for research—in hard dollars or through a MiFID II-governed RPA—without being considered, and possibly having to register as, an investment adviser under the Investment Advisers Act of 1940; (2) investment advisers may continue to aggregate client orders for purchases and sales of securities, with some clients paying different amounts for research because of MiFID II requirements, but with all clients continuing to pay the same average price and execution cost for a given security in an aggregated order; and (3) investment advisers may continue to rely on the soft dollar “safe harbor” under Section 28(e) of the Securities Exchange Act of 1934 when making payments to an executing broker-dealer out of client assets for research alongside execution payments through the use of a MiFID II-compliant RPA, provided that conditions of the Section 28(e) safe harbor are otherwise met.

_{1 An investment adviser may retain a non-EU domiciled investment adviser that is contractually required to comply with MiFID II or equivalent requirements.  In general, the extent of MiFID II’s impact on a U.S. firm depends largely on the organization’s scope of business and services, client profile, trading platform and sub-advisory arrangements, among other things.  Questions concerning the application of MiFID II should be directed to a member of Vedder Price’s Investment Services Group, including Juan Arciniegas and Joseph Mannon.  Please see the last page of this Regulatory Update for contact information.}