During his remarks at a meeting of the International Bar Association’s Asset Management Industry Conference on Global Challenges and Opportunities in Boston, Commissioner Uyeda commented on investment research and the research rules.
Commissioner Uyeda commented favorably on the United Kingdom’s Financial Conduct Authority’s consultation on modifying certain research unbundling rules required by the UK Markets in Financial Instruments Directive (“UK MiFID”), which were derived from the European Union’s MiFID II. He noted the importance of research to well-functioning capital markets. The Commissioner made two interesting observations. First, that the decline of third-party investment research may increase the risk that market participants might place undue reliance on social media and influencers as these will tend to fill the information vacuum. In turn, this would have the effect of resulting in a less informed investing population and in less efficient markets, both of which would lead to an increase in the cost of capital. He also observed that regulators are demanding additional disclosures from public companies, including, for example, climate-related disclosures and disclosures relating to cyber security incidents. The additional disclosure may be difficult to process by investors without the assistance of expert views, like those of research analysts.
The Commissioner reviewed the regulatory framework relating to research, including Section 28(e) of the Securities Exchange Act, the Global Research Settlement and Regulation AC. He contrasted the U.S. approach to the approach in the EU and the UK, where the bundling of execution and research have been viewed as an inducement to asset managers and, as a result, an investor protection issue. Therefore, MiFID II requires managers to pay for research separately from execution services, charge clients a separate fee, or pay for research. MiFID II’s research rules may have intended for independent research and lower commissions to offset the reduction in sell-side research; however, it appears that it may have not accomplished these goals. Instead, it has had unintended results, such as a decline in research relating to small and medium-sized companies. In addition, MiFID II’s inducements regime has given rise to conflicts of law issues for U.S. broker-dealers. The SEC’s Division of Investment Management issued temporary no-action letter relief to permit U.S. broker-dealers to comply with MiFID II’s research requirements and continue their business models. Despite significant efforts to seek an extension, as well as proposed legislation that would have provided a fix, the relief expired in July 2023.
The Commissioner recommends that the SEC undertake a retrospective review of Regulation AC, follow through with the 2017 recommendation from the U.S. Department of the Treasury and conduct a holistic review of the Global Research Settlement and the research analyst rules, and determine which provisions should be retained, amended, or removed, with the objective of harmonizing a single set of rules for all financial institutions.
Significant concerns also have been expressed about the role of equity research for smaller and medium–sized public companies. In 2023, the SEC’s Small Business Capital Formation Advisory Committee considered the role of equity research in anticipation of the sunset of MiFID relief and adopted a recommendation for the SEC relating to research. The Office of the Advocate for Small Business Capital Formation has considered the role of research for smaller public companies. In its 2023 annual report, for example, the OASB noted that small public companies place greater importance on increasing research coverage than large or mega-cap public companies. The average number of analysts covering a mega-cap public company is more than four times higher than at small public companies. Legislation introduced in the House, in the Financial Services Committee, would mandate a study of the SEC’s research rules.
See the full text of the Commissioner’s remarks here.
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