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].
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.
Let me guess: I’m sorry I asked
Resources
- ↑ Just wait!! There IS!
- ↑ Details fiends: see Section 202(a)(11) of the Investment Advisers Act.
- ↑ 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.