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Compliance Update – August 2017

24th August 2017

Welcome to our August compliance update! In this issue we examine US regulation that affects trade ideas, including FINRA’s recently closed consultation on its proposed safe harbour for desk research, the SEC’s possible no-action letter on payment for research via cheque, and observations on the way the US and European regulatory regimes are converging.

  • FINRA recently closed its consultation on the proposed safe harbour for desk communications including trade ideas
  • The industry response is that the safe harbour is unnecessary, because desk communications are already recognised as different from fundamental research
  • A possible no-action letter from the SEC, exempting brokers from registering as investment advisers if they accept cash payment (rather than commission) for research, would allow US brokers to more easily meet MiFID II unbundling obligations
  • Overall we see treatment of trade ideas by regulators on both sides of the Atlantic converging

FINRA safe harbour and trade ideas

The good news for alpha capture is that FINRA’s proposed safe harbour makes it clear that trade ideas should be regarded as a desk communication and not fundamental research in the US, and would be included in the safe harbour if it is enacted. Industry responses to FINRA’s consultation question the value of the safe harbour on the basis that the additional protection FINRA is offering is unnecessary, and also suggest the language may be confusing. For example SIFMA, the broker representative body, comments that the proposal as it stands could confuse rather than clarify the distinctions between desk communications and investment research. SIFMA proposes a broad definition for desk communications, which if adopted by FINRA would provide helpful protection for desk communications within the safe harbour.

Both SIFMA and FINRA suggest that desk communications risk rising to the level of fundamental research if they include a long term target price or investment rating. For this reason TIM provides the option to remove the target price from idea creation screens for a broker’s US sales staff. Do contact our account management team if you would like this option added.

As trade ideas are specifically defined as desk communications, there is no requirement for the creators of ideas to meet the disclosure obligations of research analysts.

Payment for ideas in cash, and registering as an Investment Advisor

Some brokers in the US have had concerns historically that if they receive cash rather than flow for trade ideas, they must register as an investment advisor.

The SEC helpfully made an exemption for research and other broker services from the Investment Advisers Act, if paid via a Client Commission Arrangement (CCA). The SEC’s no-action letter for Convergex in 2010 is explicit in confirming that payments for research via a CCA protect the broker being paid from the need to register as an Investment Advisor. CCAs are straightforward to set up with an existing broker counterpart. A portion of the commission paid to the existing broker counterpart is then paid to a research provider (or indeed a provider of other broker services such as desk research).

Possible SEC no-action letter

The SEC Chairman Jay Clayton said in June soon after taking office that the SEC would examine potential adverse impacts of MiFID II on US-based institutions. There is considerable industry pressure for an early announcement on any change, perhaps as soon as October, to allow the industry to prepare properly for MiFID II. One likely outcome is that the SEC will will build on its Convergex letter to state it will take no action even if brokers accept payment for research via a cheque outside of a CCA, when they are not registered as Investment Advisers.

Similarities between the trade ideas regimes in Europe and the US

The treatment of trade ideas are similar in most respects on both sides of the Atlantic. Both regulatory regimes allow asset managers to pay for trade ideas from client funds because they add value to the investment process. Both regimes exempt the providers of trade ideas from the provisions that apply to research analysts (in the US provided that the desk communication does not rise to the level of research). In Europe disclosure obligations for sales people are defined by the Market Abuse Regulation, and as in the US are less onerous for sales people than those for research analysts (see our website). An SEC no-action letter around research payments in cash would bring the two regulatory environments closer still. 

Want to discuss further with us?

We are working with our sell and buy-side TIM clients to prepare for the new regulatory regime in Europe, and changes that are taking place in North America. While our focus is primarily trade ideas, we have gained a good picture of how the market is preparing for research unbundling in general. We would welcome the opportunity to discuss and contribute to your preparations. Please contact our compliance team if you would like to have a short meeting with us to discuss.