THE PICKARD WASHINGTON REPORTON REGULATION OF THE FINANCIAL MARKETSAPRIL 2015

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THE PICKARD WASHINGTON REPORT

ON REGULATION OF FINANCIAL MARKETS

PREFACEThe 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, Mari-Anne 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 SEC’s Division of Enforcement. Mr. McLeod previously served as Attorney Adviser to the SEC’s 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.

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TABLE OF CONTENTS

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

EUROPEAN REGULATION OF CLIENT COMMISSION (SOFT DOLLAR) ARRANGEMENTS IN FLUX ...........................1

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

2. ESMA Issues Final Technical Advice to the European Commission Addressing the Receipt of Research by Portfolio Managers .....................................................................................................1

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

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

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

SEC ANNOUNCES APPOINTMENT OF EQUITY MARKET STRUCTURE ADVISORY COMMITTEE .................... 4

NYSE PROPOSES TO INTRODUCE A MIDDAY AUCTION ......................................................................... 5

1. Structure of the Proposed NYSE Midday Auction Submitted to the Commission .............................................................5

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

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

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

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

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

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

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

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1 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.

2 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).

3 Final Report, ESMA’s Technical Advice to the Commission on MiFID II and MiFIR, ESMA /2014/1569 (the “ESMA 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 broker-dealers 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 firm’s 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 ESMA’s 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.

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> 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 firm’s 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 firm’s 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 FCA’s 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 ESMA’s 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 FCA’s Feedback Statement indicates that the FCA expects final acts to be adopted by January 2016.

4 FS 15/1 Feedback Statement on DP 14/3- Discussion on the use of dealing commission regime.5 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.

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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.

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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 Committee’s 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 Committee’s 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 O’Hara, 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 White’s 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.

6 SEC Rel. No. 34-74092 (Jan. 20, 2015). 7 See 4th Quarter 2013 PWR.

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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 STOCKSAs 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 AUCTIONNYSE 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 PAUSEDuring the Midday Auction Pause, the Exchange will maintain resting orders on the Exchange’s 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.

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CONCLUSION OF THE MIDDAY AUCTION PAUSEWhen 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 DMM’s 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.

PRICINGAs 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 DATEShould 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 NYSE’s 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.

CORPORATE HEADQUARTERSWestminster Research, a member company of ConvergexTimothy O’Halloran and Christopher Tiscornia, Co-Presidents1633 Broadway, 48th FloorNew York, NY 10019212.448.6050800.367.8998

LEE A. PICKARDPickard and Djininis LLPAttorneys at Law1990 M Street, N.W.Washington, DC 20036t: 202.223.4418

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