Template:Investment research and the Investment Advisers Act 1940
Securities Exchange Act Anatomy™
Section 28(e), Securities Exchange Act 1934 (view template)
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Investment research and Investment Advisers Act: a safe harbor for broker/dealers
Unless there is a safe harbor[1], paying a broker/dealer for investment research creates issues under the Investment Advisers Act because the SEC considers a fee for research “advice” to be “special compensation”, for which a person must be a registered investment adviser[2] under the Investment Advisers Act of 1940.
Hey - stay with me. Stop staring out the window. This is interesting.[3]
Typically, broker dealers are not registered investment advisers. Can be, but usually aren’t.
There is, of course, a safe harbor. It is set out in Section 28(e) of the Securities Exchange Act of 1934: to qualify for it, a broker/dealer’s advice must be “solely incidental” to its provision of “broker/dealer services”.
Under SEC guidance “commissions” may be used to purchase research on a “soft dollar” basis.
The definition of “commission” is important:
- a fee that a broker/dealer levies for executing a securities transaction as agent.
Extensions and exceptions
- Riskless principal: OK: The SEC extended the safe harbor to certain riskless principal transactions in exchange-listed securities in 2001, riskless principal really being a form of quasi-agency.
- Swap: Not OK: The safe harbor doesn’t apply to swap transactions: By definition swaps are bilateral, full-principal contracts. They cannot be agency or riskless principal[4]. The swap dealer takes a fee (as principal) that is no sense a “commission”. The swap dealer does not act as agent (or quasi-agent).
A superbly literalist, non-sensical view of the world, but there you have it. It wouldn’t be the first time, America.
So, what does this mean then?
This means a US broker-dealer can provide research to its clients without having to register with the SEC as an investment adviser so long as it doesn’t earn any “special compensation” relating to the research. A bundled trading commission is the traditional means of compensating a broker-dealer for execution and research in a way that avoids special compensation.
Sorry you asked?
Let me guess: You’re thinking, “I’m sorry I asked”. I know I’m sorry you asked.
See also
- ↑ Just wait!! There IS!
- ↑ Details fiends: see Section 202(a)(11) of the Investment Advisers Act.
- ↑ To a US attorney.
- ↑ You could argue this isn't true for delta-one synthetic prime brokerage arrangements but, it if you know what’s good for you, you wouldn’t.