Division of Investment Management Staff Issues No-Action Letter Permitting Aggregation of Client Orders for Securities Transactions Subject to MiFID II
In a letter to the Investment Company Institute (ICI), the staff of the SEC’s Division of Investment Management provided assurance that it would not recommend that the SEC take enforcement action under Section 17(d) of the Investment Company Act of 1940 and Rule 17d-1 thereunder, or Section 206 of the Advisers Act, against an investment adviser that aggregates client orders for the purchase or sale of securities in reliance on the staff’s position in the 1995 no-action letter to SMC Capital, Inc. (SMC), while accommodating differing arrangements regarding the payment for research that will be required by MiFID II.
In the SMC no-action letter, the SEC staff took the position that the mere aggregation of orders for advisory clients, including collective investment vehicles in which the adviser, its principals or employees have an interest, would not violate Section 17(d) of the 1940 Act, Rule 17d-1 thereunder or Section 206 of the Advisers Act if the adviser implements procedures designed to prevent any account from being systematically disadvantaged by the aggregation of orders.
The standard set forth in the 1995 SMC no-action letter required that (1) once an aggregated order was executed, the trade would be allocated among clients in accordance with a pre-trade written statement specifying the participating client accounts and the intended allocation among them (Allocation Statement), and, if the order was only partially filled, the trade would be allocated pro rata based on the Allocation Statement; (2) each client that participated in an aggregated order would participate at the average share price; and (3) transaction costs would be shared pro rata based on each client’s participation in the transaction In its request for no-action relief, the ICI stated that following the implementation of MiFID II, within a given aggregated order, (1) clients (including registered funds) may pay total transaction costs that include the cost of execution as well as research services; whereas (2) other clients may pay different amounts in connection with the same trade (including possibly execution costs only). As a result of the various potential research arrangements and combinations thereof, clients may not pay a pro rata share of all costs (i.e., research payments) associated with an aggregated order. The ICI asserted that absent no-action relief expanding the relief in the SMC no-action letter, investment advisers might be forced to place into the market competing orders in the same security, possibly resulting in worse execution for clients overall and the potential for one set of clients to receive a benefit at the expense of another.
The relief granted by the SEC staff permits investment advisers to continue to aggregate client orders (including orders executed on behalf of registered funds) for purchases and sales of securities, with some clients paying different amounts for research because of MiFID II requirements, but with all clients continuing to pay the same average price and execution cost for a given security in an aggregated order. The relief is conditioned on the requirement that an investment adviser has adopted policies and procedures reasonably designed to ensure that:
(1) each client in an aggregated order pays the average price for the security and the same cost of execution (measured by rate);
(2) the payment for research in connection with the aggregated order will be consistent with each applicable jurisdiction’s regulatory requirements and disclosures to the client; and
(3) the subsequent allocation of such trade will conform to the adviser’s Allocation Statement and/or the investment adviser’s allocation procedures.
Furthermore, the relief does not apply to an investment adviser that is not subject to the requirements of MiFID II (either directly or contractually).
In a public statement accompanying the letter, the SEC stated that this relief provides clarity and consistency to investment advisers by permitting the continued aggregation of orders while addressing the differing arrangements regarding the payment for research that will be required by MiFID II.
The Division of Investment Management staff’s no-action letter to the ICI concerning aggregation of client orders under MiFID II is available at: https://www.sec.gov/divisions/investment/noaction/2017/ici-102617-17d1.htm