Broker-dealer investment research serves an important function by contributing to a richer information environment for market participants, particularly by providing analysis that can assist investors in digesting the increasing amount of regulatory disclosures from public companies. In so doing, sell-side research plays a role in the efficient market hypothesis and promotes price discovery.
In the United States, asset managers typically pay for sell-side research through bundled client payments for brokerage commissions and research, i.e., “soft dollar arrangements.” However, in 2018, the European Union’s Markets in Financial Instruments package (“MiFID II”) generally required European and U.K. asset managers to change how they paid for sell-side research. Instead of using soft dollar arrangements, these managers were required to pay for this research from their own assets, or from a research payment account funded with client assets, or some combination.
Capital markets financial services are increasingly a global business and MiFID II presented challenging conflicts of law issues as to how U.S. broker-dealers could be paid for research. To this end, the SEC staff issued relief in the form of a no-action letter to permit broker-dealers to receive separate payments for research without being subjected to regulation as investment advisers (“MiFID II Relief”). The MiFID II Relief expired on July 3, 2023. However, unintended effects resulting from MiFID II have prompted the European Union and the United Kingdom to consider whether to ease the unbundling requirements to help facilitate capital formation for smaller companies, among other considerations.
I am disappointed that the SEC staff has decided not to extend the MiFID II Relief for a modest additional period to accommodate these potential changes. The MiFID II Relief sought to resolve a conflicts of law issue caused extraterritorially, and an extension would have been consistent with that approach.
I am also concerned that the expiration of the MiFID Relief will make it more difficult for U.S. broker-dealers to provide research. While sell-side research has its inherent conflicts of interest, significant restrictions that result in a dearth of sell-side research can result in the outsized prominence of other less credible sources, such as internet speculation, that can impact market prices and increase volatility and for which SEC oversight may be limited. This result can have adverse consequences for mid-sized and smaller public companies.
In this regard, the SEC is long overdue for a holistic review of the regulatory framework for investment research. Such an effort should include consideration of rules to replace the global research analyst settlement with 12 major broker-dealer firms, which was instituted 20 years ago. The SEC should also consider harmonizing, where appropriate, the different rules for research analysts for various communications with a view to facilitating investment research. Inappropriate and poorly-designed restrictions on investment research resulting in a more ill-informed marketplace serve neither investors nor public companies.