Investment Management Alert

Transcription

1 July 2010 Authr: Anna Paglia Mark R. Greer K&L Gates includes lawyers practicing ut f 36 ffices lcated in Nrth America, Eurpe, Asia and the Middle East, and represents numerus GLOBAL 500, FORTUNE 100, and FTSE 100 crpratins, in additin t grwth and middle market cmpanies, entrepreneurs, capital market participants and public sectr entities. Fr mre infrmatin, visit The Cmmittee f Eurpean Securities Regulatrs Prvides Guidance t Investment Firms n Prper Practices fr Inducements The Cmmittee f Eurpean Securities Regulatrs ( CESR ) published n April 19 a reprt 1 reviewing the gd and pr practices n inducements (r cmpensatin) exhibited by mre than 150 regulated Eurpean investment firms (the Reprt ). The Reprt prvides firms with a benchmark against current industry practices t measure their effectiveness in cmplying with the rules n inducements as stated in Article 19(1) f the Markets in Financial Instruments Directive ( MiFID ), 2 and in Article 26 f the MiFID implementing Directive 2006/73/EC ( Implementing Directive ). CESR defines gd practices as industry practices that CESR cnsiders t be sensible actins fr investment firms t fllw. Althugh CESR endrses and encurages these practices, it recgnizes that it is smetimes reasnable fr different types f firms t fllw different rutes t cmply with the same legal requirements. CESR uses the term pr practices t identify thse industry practices that CESR cnsiders t be imprudent actins fr investment firms t fllw. 1. Inducements Accrding t Article 26 f the Implementing Directive, investment firms can pay/prvide (r be paid/prvided) the fllwing cmmissins, fees r nn-mnetary benefits in relatin t the prvisin f an investment r ancillary service t a client: a) fees, cmmissins r nn-mnetary benefits paid by, r n behalf f, the client, b) payments and nn-mnetary benefits paid by, r n behalf f, a third party, prvided that (i) the firm clearly disclses t its clients the nature and amunt f the fee r the methd used t calculate the fee when the amunt cannt be ascertained befrehand prir t prviding the service, and (ii) the payment r nn-mnetary benefit is designed t enhance the quality f the service and des nt hinder the firm frm acting in the client s best interests, r c) fees that are prper fees and are necessary t prvide investment services (fr example, custdy csts, settlement and exchange fees, regulatry levies r legal fees). Prper fees d nt create cnflicts with the firm s duties t act hnestly, fairly and prfessinally in accrdance with the best interests f its clients. 1 CESR/10-295, Inducements: Reprt n Gd and Pr Practices. 2 Directive 2004/39/EC.

2 2. CESR s Guidance n Inducements After CESR released its initial recmmendatins n inducements in 2007, 3 CESR published a cnsultatin n Octber 14, 2009, seeking cmments frm investment firms n what they believe wuld cnstitute permissible payments under MiFID. Frm the respnses t the cnsultatin paper, CESR develped guidance, published in the Reprt and in a cmpanin feedback statement n the respnses released n the same date, 4 t help firms understand the behavir that regulatrs encurage and discurage, including: (i) classifying payments and benefits and establishing an effective firm cmpliance plicy, (ii) identifying prper fees, (iii) receiving fees that enhance client services and that are in the client s best interest, and (iv) disclsing t clients the fees received under the inducements rules. Als, CESR asked investment firms t prvide their views as t the crss-brder challenges they face as a result f Member States implementatin f the inducements rules. (i) Classifying Payments and Creating an Effective Cmpliance Plicy The Reprt emphasizes that arrangements and prcedures are essential in fulfilling investment firms bligatins under the MiFID inducements rules. Hwever, the Reprt adds that firms enjy a certain degree f flexibility in the apprach t be adpted accrding t the nature, scale and cmplexity f their business and the nature and range f investment services and activities undertaken in the curse f that business. 5 Regardless f the differences in firms nature and size, CESR recmmends that: Investment firms mnitr and regularly assess their prcedures effectiveness and adequacy. 3 CESR/07-228b, Inducements Under MiFID and CESR/07-085, CESR s Level 3 Recmmendatins n the List f minimum recrds under Article 51(3) f the MiFID Implementing Directive. 4 CESR/10-296, Feedback Statement, Inducements: Gd and Pr Practices. 5 CESR/10-295, Inducements: Reprt n Gd and Pr Practices, at 9. A firm s senir management be invlved directly in develping the prcedures t cmply with the Implementing Directive. Internal cmpliance prcedures ensure that each payment r benefit is assessed fr its cmpliance with the Implementing Directive prir t the firm receiving r prviding that payment r benefit. CESR suggested that a firm s apprach t dealing with inducements can be included as an integral part f the firm s general cnflicts f interest plicy r in a separate plicy n inducements. The Reprt als states that effective prcedures shuld wrk thrugh the fllwing prcess: Identify the relevant payments and benefits that ccur fr the firm. Classify the payments r benefits under Article 26 as either between the firm and the client (Article 26(a)) r between the firm and a third party (Article 26(b)). If a payment r nnmnetary benefit is between a firm and a client, MiFID rules require n additinal verificatin fr cmpliance purpses. Evaluate whether, by its nature, the payment r nn-mnetary benefit between a firm and a third party is a payment necessary fr prviding services, such as custdy csts, settlement and exchange fees, regulatry levies r legal fees under Article 26(c) (i.e., a prper fee). If nt, evaluate whether the payment r benefit creates a cnflict with the firm s duty t act in the client s best interests. Arrange that, nce a payment r nn-mnetary benefit has been assessed as an inducement permitted under Article 26(b) r (c), the firm keeps cmplying with the Implementing Directive n a cntinuus basis. Prevent any payment r benefit that des nt cmply with the Implementing Directive frm being made r received. July

3 (ii) Acting in the Best Interest f the Client and Payments Designed t Enhance the Quality f the Service Prvided t the Client Article 26(b) requires that all payments and nnmnetary benefits must be designed t enhance the quality f service t a client and t avid impairing cmpliance with a firm s duty t act in the best interests f its clients. T meet the designed t enhance the quality f service requirement, firms must prvide an expected benefit t the relevant client when the firm is receiving a payment r nn-mnetary benefit. The Reprt states that firms shuld cnsider the fllwing factrs t determine if the payment r nn-mnetary benefit enhances the quality f the service t the client: the type f service prvided, the expected benefits t the client and t the firm, whether there is an incentive likely t change the firm s prper behavir, the relatinship between the firm and the entity invlved with the benefit, and the nature f the item. The Reprt ntes situatins where payments and nn-mnetary benefits can cause cnflicts, including where investment firms that prvide investment advice receive payments frm prduct prviders and where investment firms that prvide prtfli management services receive payments frm prduct prviders r firms executing rders. Accrding t CESR, cnflicts arise in these situatins because the firm has mre influence ver the service the client receives than when it prvides services such as the transmissin f rders. Respndents cited a number f ways they manage ptential cnflicts f interest, including: passing t clients the rebates received frm third parties, negtiating the same level f rebates withut regard t the prmter, implementing infrmatin walls t prevent leaks f infrmatin abut the payments received t the departments that prvide the service t the client s that advisrs, sales staff and prtfli managers in cntact with clients d nt have access t infrmatin abut the agreed rebates, and using a best executin plicy t ensure brkers are chsen n the basis f their executin services and nt the quality f the research they prvide. Respndents als claimed several reasns why third-party payments r nn-mnetary benefits enhanced the quality f services prvided t clients, but CESR fund sme t be unacceptable, including: Payments that cver csts that wuld therwise be charged t the client. The client is likely t end up paying the csts n matter hw they are charged, directly r indirectly. 6 Rewarding a firm s sales frce by emphasizing sme financial prducts ver ther cmparable prducts that receive less lucrative payments. Investment firms receiving payments fr services when the business vlumes sent t firms executing client rders reach certain threshlds. Rewarding an investment firm s advisers and sales staff fr the levels f cmmissins generated by the sales they make t clients. The Reprt fund that firms were uncertain abut the designed t enhance language f the rules, nting that firms fcus n actual enhancement and that there des nt appear t be a cmmn apprach amngst investment firms in determining when it is acceptable t prvide r receive third-party r nnmnetary benefits. Stating that the designed t language implies a wider fcus, CESR reemphasizes that such assessment shuld be made at the time the arrangement is prpsed rather than after a payment. 6 CESR/10-295, Inducements: Reprt n Gd and Pr Practices, at 82. July

4 (iii) Prper Fees Article 26(c) f the Implementing Directive permits prper fees which enable r are necessary fr the prvisin f investment services and that by their nature cannt give rise t cnflicts with the firm s duty t act hnestly, fairly and prfessinally in accrdance with the best interests f the client. Such fees include: custdy csts, settlement and exchange fees, regulatry levies, r legal fees. Thugh recgnizing that the categry f prper fees is intended t be narrw, the Reprt states that prper fees als can include: fees paid by a firm t access and perate n a given executin venue, custdy-related fees in cnnectin with crprate events, including sharehlders meetings r dividend distributins, and additinal items required t prvide services t the client, including payments t infrmatin prviders and cnsultants fr services related t the prvisin f the investment r ancillary service, such as tax advice t an intermediary abut a placement it will manage. The Reprt states that, in general, a fee nly can be prper if the investment firm is paying it t the third party rather than if the firm is receiving it frm the third party. Otherwise it wuld be difficult fr the nature f the payment (received by the investment firm), t meet the requirement f the absence f any ptential cnflict with the best interests f the client. 7 Hwever, the Reprt ntes that sme payments by the investment firm culd give rise t cnflicts f interest even if the payment wuld qualify, n its face, as a prper fee. Fr example, the fllwing payments culd give rise 7 CESR/10-295, Inducements: Reprt n Gd and Pr Practices, at 45. t a cnflict f interest: rebates that an investment firm receives in cnnectin with payments, such as t access and perate n a given executin venue, and the venue rebates mney if a certain vlume threshld is reached, underwriting fees where the investment firm participating in the underwriting als sells the financial instruments issued t investrs, cmpensatin t tied agents by an investment firm (as these are deemed an internal payment within the firm), intra-grup payments, as the Reprt nted that these were nt prper fees and that payments made between distinct legal entities belnging t the same grup are t be treated in the same way as payments utside the grup, and payments by an investment firm t an intrducing brker. 3. Prper Disclsure f Inducements While Article 26 f the Implementing Directive permits firms t disclse nly the essential terms f the arrangements in the frm f a summary disclsure, the Reprt states that such a disclsure must prvide adequate infrmatin t the client t enable him (i) t relate the disclsure t the particular investment r ancillary service that is prvided t him, r t the relevant prducts, (ii) t make an infrmed decisin whether t prceed with the investment r ancillary service, and (iii) t decide whether t ask fr the full infrmatin. T meet these requirements, the Reprt recmmends that firms disclsure be prper in cntent, methd and timing: Cntent. The disclsure shuld include: The exact amunt f the third-party payments and nn-mnetary benefits prvided r received in relatin t the service r services t be prvided t the client. The types f third parties frm which the firm receives r t which it prvides payments r nn-mnetary benefits. July

5 When service is prvided prir t payment, a reasnable band range f the payments alng with the methd f calculating the amunt. When the exact amunt f payments r the methd f calculating the amunt varies depending n (i) the class f instrument, firms shuld prvide the infrmatin per service prvided and per class f instrument, r (ii) the prvider f the financial instruments, the firm shuld identify any material differences. If a summary disclsure, ntice that the investment firm receives research frm brkers that receive frm the firm rders fr executin, and, if a detailed disclsure, further detail including an estimate f the value f the investment research. A statement that the client can request mre detailed infrmatin and t whm such a request can be directed. Methd. Accrding t the Reprt, the disclsure shuld be: Clear, fair and nt misleading regarding third-party payments and nn-mnetary benefits. Easily accessible and in a user-friendly frmat. Clear regarding the minimum and maximum levels f third-party payments. CESR advises that when firms in practice receive between specific minimum and maximum levels f payments, that they disclse thse amunts rather than just disclse the maximum f the range. Timing. The disclsure shuld be sent t clients with enugh time t prvide them sufficient pprtunity t decide whether they will prceed with the investment r request mre infrmatin. 4. Crss-Brder Cmpliance with Inducement Rules The Reprt states that, while the majrity f respndents did nt need t adpt new prcedures acrss Member States t cmply with the inducements rules, sme internatinally active grups that perate subsidiaries acrss Eurpe were affected. The Reprt adds that while thse firms had t supplement their prcedures acrss Member States, the existing differences between the Member States implementatins f the inducements rules were nt significant barriers t thse firms engagement in crss-brder activities. Nevertheless, the Reprt cites the respnse f ne firm, which stated that the line taken n an acceptable summary disclsure, types f payment and remuneratin structures differs between Member States making it difficult t achieve a cnvergent applicatin f the MiFID inducements rules. 8 Fr example, it nted that at least tw Member States have rules limiting the payments received by investment firms prviding prtfli management services frm firms executing client rders. 9 The Reprt ntes that such situatins illustrate a need fr firms t have a better understanding f the applicatin f the inducements rules. 8 CESR/10-295, Inducements: Reprt n Gd and Pr Practices, at CESR/10-295, Inducements: Reprt n Gd and Pr Practices, at 136. July

6 Anchrage Austin Beijing Berlin Bstn Charltte Chicag Dallas Dubai Frt Wrth Frankfurt Harrisburg Hng Kng Lndn Ls Angeles Miami Mscw Newark New Yrk Orange Cunty Pal Alt Paris Pittsburgh Prtland Raleigh Research Triangle Park San Dieg San Francisc Seattle Shanghai Singapre Spkane/Ceur d Alene Taipei Tky Warsaw Washingtn, D.C. K&L Gates includes lawyers practicing ut f 36 ffices lcated in Nrth America, Eurpe, Asia and the Middle East, and represents numerus GLOBAL 500, FORTUNE 100, and FTSE 100 crpratins, in additin t grwth and middle market cmpanies, entrepreneurs, capital market participants and public sectr entities. Fr mre infrmatin, visit K&L Gates cmprises multiple affiliated entities: a limited liability partnership with the full name K&L Gates LLP qualified in Delaware and maintaining ffices thrughut the United States, in Berlin and Frankfurt, Germany, in Beijing (K&L Gates LLP Beijing Representative Office), in Dubai, U.A.E., in Shanghai (K&L Gates LLP Shanghai Representative Office), in Tky, and in Singapre; a limited liability partnership (als named K&L Gates LLP) incrprated in England and maintaining ffices in Lndn and Paris; a Taiwan general partnership (K&L Gates) maintaining an ffice in Taipei; a Hng Kng general partnership (K&L Gates, Slicitrs) maintaining an ffice in Hng Kng; a Plish limited partnership (K&L Gates Jamka sp.k.) maintaining an ffice in Warsaw; and a Delaware limited liability cmpany (K&L Gates Hldings, LLC) maintaining an ffice in Mscw. K&L Gates maintains apprpriate registratins in the jurisdictins in which its ffices are lcated. A list f the partners r members in each entity is available fr inspectin at any K&L Gates ffice. This publicatin is fr infrmatinal purpses and des nt cntain r cnvey legal advice. The infrmatin herein shuld nt be used r relied upn in regard t any particular facts r circumstances withut first cnsulting a lawyer K&L Gates LLP. All Rights Reserved. July