Effective July 4, 2023, broker-dealers in the U.S. will no longer be able to receive “hard dollars” for providing research to EU or UK investment managers without also being registered as an Investment Adviser.

What happened?

In order to answer that question, we must go back to 2017 when the world was preparing to comply with the EU’s second Markets in Financial Instruments Directive (fondly known as MIFID II). Under MIFID II, which went into effect in 2018, EU Investment Managers were required to unbundle execution fees from research costs, a practice known as “soft dollars” and begin using "hard dollars" for receipt of research.

Here in the U.S., a broker-dealer was able to provide research along with execution services under a “soft dollar” arrangement without having to also register as an investment advisor. The theory being that the “provision of research” was incidental to the broker-dealer’s primary business: “trade execution.” MIFID II posed a serious challenge for U.S. broker-dealers who would now be required to receive direct payments for research from EU investment managers (i.e., receive hard dollars which is something only a registered investment adviser can do).

On October 26, 2017, the staff of the SEC threw a temporary lifeline to broker-dealers by issuing a No-Action letter that, in essence, allowed U.S. broker-dealers to receive hard dollars from an investment manager that is required to pay for research directly under MIFID II without having to register as an investment adviser. The No-Action relief was set to expire on July 3, 2020 and the Staff extended it to July 3, 2023.

I think you can figure out what happened next. Last year the SEC Staff announced it would no longer extend the No-Action relief. As a result, starting this Independence Day, broker-dealers must cease receiving hard dollars for research issued to MIFID II investment managers or register as an investment adviser if they wish to continue the practice.

History seems to be repeating itself.

Just like the British ultimately accepted that they could no longer “own” the colonies given the insurmountable conflict, most U.S. broker-dealers have recognized that they can no longer “own” this activity and are choosing to move their research operations into an affiliated investment adviser within the U.S. or to an offshore non-registered affiliate.