The Securities and Exchange Commission is taking steps to ease the concerns of block-trading houses reluctant to accept checks for their research under the popular client commission arrangements, or CCAs.
Some bulge-bracket firms have balked at joining their competitors’ CCA programs because they worried they would be subject to the rules of the Investment Advisers Act of 1940 (see Traders Magazine, August). That would preclude their ability to commit capital on trades with those institutional accounts that are paying them for their research in hard dollars.
Bob Plaze, associate director in the SEC’s Division of Investment Management, told attendees at a recent industry conference that the SEC was working on two fronts that would likely make it palatable for block-trading shops to accept hard-dollar payments under CCAs.
At the Securities Industry and Financial Markets Association’s annual institutional brokerage conference last month, Plaze outlined possible solutions for block traders stymied by the Advisers Act.
First, the broker-dealer can structure its legal relationships so its institutional clients are the investment management companies and not the funds themselves. This approach is used by Lehman Brothers-with the tacit approval of the SEC-in some of its dealings with fund giant Fidelity Management Company.
“If the client is the money manager rather than the mutual fund,” Plaze said, “the broker providing the research is not restricted in its ability to do principal transactions with the mutual fund. I would expect sometime in the next couple of months that would be formalized.”
For broker-dealers that do not want to structure their relationships with the fund companies themselves, Plaze said, they may still be able to trade on a principal basis with their accounts. If the research is “generic,” Plaze said, the principal-transaction rules would not apply.
Also, a new rule proposed by the SEC in September primarily aimed at retail brokerages might be applicable to institutional brokers as well, Plaze said. In September, the SEC proposed a rule permitting retail brokers offering non-discretionary fee-based accounts to trade with those accounts on a principal basis (see accompanying story). The rule, which requires brokers to verbally notify their clients they are taking the opposite of their trade, “may be available” for institutional brokers as well, Plaze suggested.
Traditionally, broker-dealers have been paid for their research with commission dollars. That is changing, though, as more money managers seek to unbundle the acquisition of research from trading services. They are utilizing CCAs to pay their execution providers with their commissions while assigning a portion of those payments to their research providers.
The Advisers Act, however, deems those hard-dollar payments “special compensation.” That subjects broker-dealers to the Advisers Act, which prohibits firms from trading with their customers on a principal basis.
“If you do unbundle now, there is an advisory relationship,” Plaze said. “But there are a couple of options or models you have available to make that kind of unbundled arrangement work.”
Amy Reich, deputy general counsel at Citi Market and Banking, said she sees the industry moving to “complete unbundling.”