Template:Investment research and the Investment Advisers Act 1940

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Securities Exchange Act Anatomy™

Section 28(e), Securities Exchange Act 1934 (view template)

28(e)(1) No person using the mails, or any means or instrumentality of interstate commerce, in the exercise of investment discretion with respect to an account shall be deemed to have acted unlawfully or to have breached a fiduciary duty under State or Federal law unless expressly provided to the contrary by a law enacted by the Congress or any State subsequent to the date of enactment of the Securities Acts Amendments of 1975 solely by reason of his having caused the account to pay a member of an exchange, broker, or dealer an amount of commission for effecting a securities transaction in excess of the amount of commission another member of an exchange, broker, or dealer would have charged for effecting that transaction, if such person determined in good faith that such amount of commission was reasonable in relation to the value of the brokerage and research services provided by such member, broker, or dealer, viewed in terms of either that particular transaction or his overall responsibilities with respect to the accounts as to which he exercises investment discretion. This subsection is exclusive and plenary insofar as conduct is covered by the foregoing, unless otherwise expressly provided by contract: Provided, however, That nothing in this subsection shall be construed to impair or limit the power of the Commission under any other provision of this title or otherwise.


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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].

Typically, broker dealers are not registered investment advisers.

There is, of course, a safe harbor. I t 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 to the Section 28(e) safe harbor, “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. 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.

The safe harbor doesn’t apply to swap transactions: By definition swap transactions are bilateral, full-principal contracts. they are not agency or riskless principal[3]. 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. 

===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 avoids accepting any "special compensation" in connection with the research. A bundled trading commission is the traditional means of compensating a broker-dealer for execution and research.

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  1. ↑ Just wait!! There IS!
  2. ↑ Details fiends: see Section 202(a)(11) of the Investment Advisers Act.
  3. ↑ You could argue this isn't true for delta-one synthetic equity prime brokerage arrangements, it if you know what’s good for you, you wouldn’t.
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