THE PICKARD

WASHINGTON
REPORT
ON REGULATION
OF THE
FINANCIAL
MARKETS
APRIL 2015

I x PICKARD WASHINGTON REPORT

THE PICKARD WASHINGTON REPORT

ON REGULATION OF
FINANCIAL MARKETS

PREFACE
The Pickard Washington Report describes and analyzes changes in the structure and
regulation of the securities markets as these changes affect the securities and banking
industries. The Report addresses specific regulatory measures initiated in Washington, D.C.
by government agencies, as well as Congressional legislative actions that have a bearing on the
financial markets. The Pickard Washington Report is written by Lee A. Pickard and distributed
on a quarterly basis by ConvergEx Group. ConvergEx Group is not responsible for its contents
and does not guarantee its accuracy, timeliness or completeness. Anthony W. Djinis, MariAnne Pisarri, Paul J. Bazil, William D. Edick, and Peter E. McLeod, partners in the law firm of
Pickard Djinis and Pisarri LLP, Craig L. Landauer, of counsel in the law firm, Larissa C. Powell
and Charlotte B. Lauren, associates in the law firm, are contributors to the Pickard Washington
Report. Mr. Djinis previously served on the staff of the Securities and Exchange Commission
as Special Counsel to the Division of Enforcement. Prior to joining Pickard Djinis and Pisarri
LLP, Mr. Bazil served as Senior Counsel on the staff of the SECs Division of Enforcement.
Mr. McLeod previously served as Attorney Adviser to the SECs Administrative Law Judges.
Lee A. Pickard is a former Director of the Division of Trading and Markets of the Securities and
Exchange Commission and is now in private practice in Washington, D.C. with the law firm of
Pickard Djinis and Pisarri LLP. ConvergEx Group is a group of affiliated broker-dealers who are
some of the leading providers of independent research, brokerage and investment services.

All rights reserved. Reproduction in any form whatsoever is forbidden without written permission. Materials have
been abridged from laws, court decisions and administrative rulings and should not be considered as legal opinions
on specific facts or as a substitute for legal counsel.
Lee A. Pickard and Pickard Djinis and Pisarri LLP are independent of and not affiliated with ConvergEx Group.
Content is general in nature and should not be construed as legal or tax advice. Consult with an attorney or tax
professional regarding your specific legal or tax situation.

APRIL 2015 x II

TABLE OF
CONTENTS

PREFACE.............................................................................................................. i

NYSE PROPOSES TO INTRODUCE A

MIDDAY AUCTION.......................................................................... 5

EUROPEAN REGULATION OF CLIENT COMMISSION

(SOFT DOLLAR) ARRANGEMENTS IN FLUX............................1

1. Structure of the Proposed NYSE Midday Auction

Submitted to the Commission..............................................................5

1. Background .................................................................................................1

a. Midday Auction Stocks....................................................................5

2. ESMA Issues Final Technical Advice to the European

Commission Addressing the Receipt of Research by Portfolio
Managers......................................................................................................1

b. Timing of Midday Auction...............................................................5

c. Midday Auction Pause......................................................................5

3. UK FCA Issues Feedback Statement to DP 14/3..........................2

d. Conclusion of the Midday Auction Pause..................................6

4. Next Steps...................................................................................................2

e. Pricing....................................................................................................6

5. Conclusion....................................................................................................3

SEC ANNOUNCES APPOINTMENT OF EQUITY

MARKET STRUCTURE ADVISORY COMMITTEE..................... 4

f. Implementation Date........................................................................6

2. Conclusion....................................................................................................6

1 x PICKARD WASHINGTON REPORT

EUROPEAN REGULATION OF CLIENT COMMISSION (SOFT DOLLAR)

ARRANGEMENTS IN FLUX
As discussed in the Third and Fourth Quarter 2014 Pickard Washington Report, earlier this year the European Securities and
Markets Authority (ESMA) and the UK Financial Conduct Authority (FCA) published proposals addressing the ability of brokerdealers in Europe to provide research to institutional portfolio managers in exchange for client portfolio commissions. Both the
FCA and ESMA have issued new releases reiterating their stances, which would curtail or eliminate the ability for investment
managers to receive research services from broker-dealers other than for hard cash. The resolution of the issue is unclear, however,
as higher bodies (the European Commission, European Parliament, and European Council) will ultimately decide the treatment of
client commission arrangements in Europe.

1. BACKGROUND
The Markets in Financial Instruments Directive 2014/65/EU (MiFID II), released in January 2014, generally prohibits portfolio
managers from accepting and retaining fees, commissions, or any monetary or non-monetary benefits from third parties such as
brokers. There is an exception from this prohibition for minor non-monetary benefits, which are defined as benefits that are
capable of enhancing the quality of service provided to a client and are of a scale and nature such that they could not be judged to
impair compliance with the investment firms duty to act in the best interest of the clients. While there is a strong argument that
this exception could encompass all investment research, ESMA published commentary in July 2014, which would have permitted
only widely-disseminated generic research to qualify as a minor non-monetary benefit.1 Such an interpretation would have
prohibited European investment managers from research that is not generic and widely-disseminated.
Seizing on the issues raised in the ESMA commentary, the UK FCA issued a Discussion Paper (DP 14/3) in July 2014 on the use
of dealing commissions to obtain research.2 DP 14/3 proposed wholesale changes to the regulatory regime in the UK, which, if
adopted in their most drastic form, could result in the end of the ability of investment managers in the UK to receive research from
brokers other than through hard dollar arrangements.

2. ESMA ISSUES FINAL TECHNICAL ADVICE TO THE EUROPEAN COMMISSION ADDRESSING THE
RECEIPT OF RESEARCH BY PORTFOLIO MANAGERS
On December 19, 2014 ESMA issued its final advice to the European Commission regarding MiFID II.3 The ESMA Report noted
that the large majority of commenters did not agree with ESMAs proposal to limit European investment managers from receiving
research other than widely disseminated generic research. Rather, commenters suggested that ESMA permit investment managers
to receive all types of research, and further suggested that the use of commission sharing agreements was an effective way to
address conflicts of interest and disclosure in the research distribution process. Instead of acting upon this suggestion, the ESMA
Report appears to have suggested an even more onerous position which, if adopted, would permit European investment managers
to receive research only by paying for such research: 1) with their own funds; or 2) through a separate research payment account
controlled by the investment manager.
The use of a special research account would be subject to a myriad of conditions, including the following:
> The account must be funded only by a specific research charge to the client that is based on a pre-established research
budget and that is not linked to the volume or value of transactions executed on behalf of the client. The total amount
of research charges may not exceed the research budget, and the investment firm must agree with each client on the
research charge and the frequency with which the research charge will be paid by the client.
> The research budget must be regularly assessed and subject to appropriate controls and senior management oversight.
The research budget may not be used to fund internal research.

ESMA, Consultation Paper on MiFID II/MiFIR, Section 2.15. Under the ESMA commentary, any research that is bespoke in content, rationed in how it is
distributed or accessed, or that has material value would not be permitted to be paid for by an investment manager through client commissions.

Discussion on the use of dealing commission regime: Feedback on our thematic supervisory review and policy debate on the market for research, DP 14/3
(July 2014).

Final Report, ESMAs Technical Advice to the Commission on MiFID II and MiFIR, ESMA /2014/1569 (the ESMA Report).

APRIL 2015 x 2

> The investment firm may delegate the administration of the research account to a third party, provided bills are paid
in the name of the investment firm without undue delay in accordance with the investment firms instruction.
> The investment firm must regularly assess the quality of research purchased and the approach to allocate research
costs as fairly as practicable to various clients.
> The investment firm must disclose to clients in advance the budgeted amount of research and the amount of the
expected research charge.
> The investment firm must disclose to clients retrospectively the total cost each of them has incurred annually for
research. Upon request by their clients or authorities, the investment firm should also provide a summary of providers
paid from this account, total amount paid, the goods and services provided to the investment firm, and a comparison of
the total amount spent from the account to the firms budget for that period.
Commenters have argued that ESMA has exceeded its mandate by attempting to impose such onerous requirements on the
research distribution process. It should be noted that there is an argument that the ESMA technical advice would permit research
that constitutes a minor non-monetary benefit to continue to be received outside the scope of the payment process set forth
above, e.g. from a broker in exchange for commissions; however, the ESMA Report states categorically that research may only be
obtained by an investment manager through direct payment or through the ring-fenced account described above, and that there
should be no payment for research linked to the payments for execution of orders.
The ESMA Report is advisory only and there will be no change to current practices in Europe until other branches of the European
Union take action on MiFID II.

3. UK FCA ISSUES FEEDBACK STATEMENT TO DP 14/3

In February 2015, the FCA issued a Feedback Statement to Discussion Paper 14/3 (the Feedback Statement).4 DP 14/3 had
stated the FCAs preference that research should be entirely unbundled from execution costs throughout the European Union.
Under this scenario, investment managers could not receive any research (proprietary or third party) from brokers through client
commission arrangements, and would instead be required to pay for such research out of their own funds, or to pass through the
cost of research to their clients. The Feedback Statement both addresses and summarizes the December 2014 ESMA Report
and comments to DP 14/3. Predictably, the Feedback Statement expresses support for the ESMA Report, as the ESMA Report
appears to have adopted the standard proposed by the FCA in DP 14/3 by proposing to permit investment managers to receive
research only by paying for it themselves or by passing charges for research through to clients.5
The Feedback Statement notes that the FCA received a number of comments that expressed concerns about the potential negative
consequences of significantly reforming the manner in which research is distributed. For example, commenters pointed out that
banning the use of brokerage commissions to pay for research would harm smaller investment managers, broker-dealers, and
independent research providers. The FCA essentially chose to summarily reject these comments.

4. NEXT STEPS
ESMA is an advisory body only, and the technical advice issued in the advisory report will not take effect unless it is adopted by the
European Commission (EC). If the EC chooses to accept ESMAs advice, it will draft proposed acts that must be submitted to the
European Parliament and European Council. The European Parliament and European Council then have up to six months to review
and object to the proposed acts before final acts can be adopted. The FCAs Feedback Statement indicates that the FCA expects
final acts to be adopted by January 2016.

FS 15/1 Feedback Statement on DP 14/3- Discussion on the use of dealing commission regime.

As discussed in section 2 above, there is an argument that the ESMA technical advice could permit research that constitutes a minor non-monetary
benefit to an investment manager to continue to be received from a broker in exchange for commissions.
5

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5. CONCLUSION
ESMA and the FCA seem determined to proceed with a regulatory standard that would require European investment firms to use
hard dollars to pay for research. Such an approach seems ill-advised. As commenters have suggested, it seems likely that moving
to hard dollar arrangements will diminish the quality and availability of research, and disproportionally impact small investment
managers and research firms.
Because other branches of the European Union must act to adopt the ESMA Report, it is possible that the regulatory regime for
client commission arrangements in Europe will not change from the current regime, despite the language in the ESMA Report and
FCA Feedback Statement. Further, we note that no action by the EU or the FCA would have any direct effect on the ability of U.S.
fiduciaries to continue to receive eligible brokerage and research services through client commission arrangements in the United
States, as such action is protected by the safe harbor provided by Section 28(e) of the U.S. Securities Exchange Act of 1934.

APRIL 2015 x 4

SEC ANNOUNCES APPOINTMENT OF EQUITY MARKET STRUCTURE

ADVISORY COMMITTEE
On January 13, 2015, the SEC announced the creation of a new Equity Market Structure Advisory Committee (the Committee),
which will focus on the U.S. equities markets.6 The Committees objective is to provide the SEC with diverse perspectives on the
structure and operations of the U.S. equities markets, as well as recommendations on matters related to equity market structure.
The Committee will focus on issues including the review of Regulation NMS, the role of exchanges in the current market structure,
and the presence and effect of conflicts in the routing and execution of equity orders. The Committees role will be solely advisory,
and the Commission alone will determine which actions to take and policies to express.
The Committee members, who were appointed by all five Commissioners, come from the financial services industry, academia and
public interest groups and will serve for a two-year term, which can be renewed by the SEC. Steven Luparello, the Director of the
SEC Division of Trading and Markets, will be the designated federal officer on the Committee, which is expected to meet four times
per year. The other Committee members are:
Matthew Andresen, Co-Chief Executive Officer, Headlands Technologies LLC
Reginald Browne, Senior Managing Director & Global Co-Head, ETF Group, Cantor Fitzgerald & Co.
Kevin Cronin, Global Head of Trading, Invesco Ltd.
Brad Katsuyama, President and CEO, IEX Group Inc.
Ted Kaufman, Professor, Duke University Law School and former U.S. Senator from Delaware
Richard Ketchum, Chairman and CEO, FINRA
Manisha Kimmel, Managing Director, Financial Information Forum
Mehmet Kinak, Vice President and Head of Global Equity Market Structure and Electronic Trading, T.Rowe Price Group
Andrew Lo, Charles E. and Susan T. Harris Professor of Finance and Director, Laboratory for Financial Engineering,
MIT Sloan School of Management and Chairman and Chief Investment Strategist, AlphaSimplex Group
Joseph Mecane, Managing Director, Barclays PLC
Jamil Nazarali, Senior Managing Director & Head of Execution Services, Citadel Securities
Eric Noll, President & CEO, Convergex Group
Maureen OHara, Robert W. Purcell Professor of Finance, Johnson Graduate School of Management,
Cornell University and Chairman of the Board, Investment Technology Group Inc.
Joe Ratterman, CEO, BATS Global Markets Inc.
Nancy Smith, Corporate Secretary & Chief Integration Officer, AARP
Chester Spatt, Kenneth B. and Pamela R. Dunn Professor of Finance, Tepper School of Business,
Carnegie Mellon University and Director of its Center for Financial Markets
Gary Stone, Chief Strategy Officer, Bloomberg Tradebook LLC
The appointment of the Committee is a natural progression of other steps SEC Chair Mary Jo White has taken to explore market
structure issues since her October 2, 2013 speech, which focused on three central areas: (i) the role of technology and maintaining
operational integrity; (ii) challenging existing assumptions about market structure; and (iii) the need to base market structure
assessments on empirical evidence.7 Chair Whites 2013 speech was closely followed by the SEC unveiling a dynamic website to
share evolving data, research and analysis as the Commission continues its review of equity market structure.

SEC Rel. No. 34-74092 (Jan. 20, 2015).

See 4th Quarter 2013 PWR.

5 x PICKARD WASHINGTON REPORT

NYSE PROPOSES TO INTRODUCE A MIDDAY AUCTION

On February 2, 2015, the New York Stock Exchange (NYSE or the Exchange) filed with the Securities and Exchange Commission
(Commission) a proposed rule change that would adopt a new rule to conduct a daily single-priced auction at a specified time
in lower-volume securities (Midday Auction) and amend an existing rule to codify the obligation of Designated Market Makers
(DMM) to facilitate the Midday Auction. The proposed rule filing states the intent as such: [t]he Midday Auction is intended to
consolidate volume, including orders of larger blocks of stock, for price discovery purposes in lower-volume securities to provide
market participants with a single-priced execution intra-day to supplement the existing opening and closing auctions. NYSE also
believes that by providing an additional opportunity to execute orders in thinly-traded securities hours before the close of trading,
the proposed rule change would further the price discovery process and enhance competition.

1.

STRUCTURE OF THE PROPOSED NYSE MIDDAY AUCTION SUBMITTED TO THE COMMISSION

MIDDAY AUCTION STOCKS

As proposed, the Midday Auction would include a subset of NYSE-listed securities with a consolidated average daily trading
volume of 1,000,000 shares or less, which represents approximately 16% of NYSE-listed securities by consolidated volume, and
that have been designated by the Exchange to be included in the Midday Auction (Midday Auction Stocks). NYSE believes that the
proposed parameters for eligible stocks are reasonably designed to include stocks that would benefit from such price discovery.
NYSE proposes to update the list of such Midday Auction Stocks at least quarterly. NYSE feels that maintaining discretion over
determining which stocks are eligible and updating the list of Midday Auction Stocks at least quarterly will allow them to add or
remove stocks depending on the trading characteristics of individual securities, considering whether they would benefit from the
Midday Auction.
TIMING OF MIDDAY AUCTION
NYSE proposes to conduct one Midday Auction in each Midday Auction Stock per trading day. The Midday Auction would not be
conducted on trading days when the Exchange is scheduled to close before 4:00 p.m. ET or if a Midday Auction Stock is halted,
paused, suspended, or not opened for trading at the time of the Midday Auction.
The Midday Auction will take place for 5 minutes at a time designated by the Exchange, which will be sometime between 11 a.m. ET
and 2 p.m. ET. During this time, investors will have an opportunity to enter interest intended for the auction. The Midday Auction
is intended to occur at that same specified time each day. The Exchange will pause trading only on the Midday Auction Stocks
by suspending automatic executions and publishing a zero quote condition (Midday Auction Pause). The Exchange believes that
publishing a zero quote condition will signal to the market that the Midday Auction has begun.
The Exchange believes that having discretion to determine the time of the Midday Auction will allow the Exchange to change
when it occurs in order to respond to market events. The proposed window is designed to allow the Midday Auction to occur when
additional price discovery for a Midday Auction Stock would be warranted. Advance notice of the timing of the Midday Auction will
be provided by Trader Update.
The proposed Midday Auction would only pause trading on the Exchange for Midday Auction Stocks. Thus, investors will still have
intra-day executions opportunities on other markets during the time that the Midday Auction occurs on the Exchange.
MIDDAY AUCTION PAUSE
During the Midday Auction Pause, the Exchange will maintain resting orders on the Exchanges book that are eligible to participate
in the Midday Auction; accept new orders that are eligible to participate in the Midday Auction, including Market-on-Open (MOO)
and Limit-on-Open (LOO) Orders, which are existing order types available for openings and reopenings; accept and process
cancellations of new and resting orders; continue to re-price and sell short orders, including MOO and LOO orders, consistent with
NYSE Rule 440B(e) (Short Sales); continue to re-price and/or cancel orders, including MOO and LOO orders, consistent with NYSE
Rule 80C(a)(5) (Limit Up-Limit Down Plan and Trading Pauses in Individual Securities Due to Extraordinary Market Volatility); and
publish Order Imbalance Information approximately every five seconds until the Midday Auction Stock re-opens.

APRIL 2015 x 6

CONCLUSION OF THE MIDDAY AUCTION PAUSE

When the Midday Auction Pause concludes, the Exchange proposes to reopen the Midday Auction Stocks at a single equilibrium
price in the same manner as in NYSE Rule 123D (Openings and Halts in Trading) for reopenings, with two exceptions: (1) one relating
to the manner that the Exchange reopens securities following a Limit Up-Limit Down (LULD) Plan pause and (2) a requirement that
the Midday Auction shall not execute at a price outside of the LULD Price Bands.
As proposed, the DMM assigned to a Midday Auction Stock will be responsible for facilitating the Midday Auction in a manner
similar to how reopenings or openings are conducted, which includes supplying liquidity as needed and conducting the Midday
Auction either manually or electronically, as provided for in NYSE Rule 123D(1).
Rule 104(a)(2) currently sets forth the DMMs obligation to facilitate openings and reopenings for each of the securities in which
the DMM is registered as required under Exchange rules, which may include providing liquidity as needed. The Exchange proposes
amending Rule 104(a)(2) to specify that the DMM has a similar obligation for the Midday Auction.
PRICING
As proposed, a Midday Auction will be priced consistent with the LULD Price Bands in effect at the time of the auction. As stated in
the proposed rule filing, the Exchange feels that this would perfect the mechanism of a free and open market and national market
system because it would assure that the Midday Auction would not be priced outside of the established parameters for trading in
that security at a given time. Since trading of the Midday Auction Stock would only be paused on the Exchange during the Midday
Auction, NYSE feels it is appropriate to defer to prices occurring on other markets and price the Midday Auction consistent with
the Price Bands. If there is a significant imbalance in a Midday Auction Stock, the Midday Auction Pause will be able to be converted
to an order imbalance halt with the approval of a Floor Governor or two Floor Officials, which is the existing process for invoking a
halt on the Exchange pursuant to NYSE Rule 123D. The Exchange will publish Order Imbalance Information during a Midday Auction
Pause, thus providing investors and the public with information regarding the Midday Auction pricing.
IMPLEMENTATION DATE
Should the proposed rule change be approved by the Commission, the Exchange proposes to announce the implementation date
via Trader Update.

2. CONCLUSION
On February 17, 2015, the Commission provided notice of NYSEs proposed rule filing to solicit comments. Comments were due
by March 16, 2015. The Commission will then either (1) by order approve or disapprove the proposed rule change, or (2) institute
proceedings to determine whether the proposed rule change should be disapproved.

ABOUT CONVERGEX
Convergex is an agency-focused global brokerage and trading related services provider that takes on the
industrys toughest challenges, from complicated trades to complex businesses. With clients interests as the
top priority, Convergex delivers comprehensive solutions that span global high-touch and electronic trading,
options technologies, prime brokerage, clearing, commission management and beyond. Headquartered in New
York with a presence in several other locations including Atlanta, Boston, Chicago, Orlando, San Francisco and
London, the company serves nearly 3,000 clients accessing over 100 global market centers.

CORPORATE HEADQUARTERS
Westminster Research,
a member company of Convergex
Timothy OHalloran and
Christopher Tiscornia, Co-Presidents
1633 Broadway, 48th Floor
New York, NY 10019
212.448.6050
800.367.8998
LEE A. PICKARD
Pickard and Djininis LLP
Attorneys at Law
1990 M Street, N.W.
Washington, DC 20036
t: 202.223.4418
CONVERGEX.COM

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