Broker...Advisor... Broker...Advisor—Let's Call the Whole Thing Off!

If you're a broker, chances are you introduce yourself to clients and prospects as a financial advisor or financial consultant. The Financial Planning Association and some consumer groups are in court in an effort to break you of that habit and the issue will be coming to a head soon. The FPA is suing the SEC to rescind a five-year-old rule, sometimes known as the Merrill Lynch exemption, that since

If you're a broker, chances are you introduce yourself to clients and prospects as a “financial advisor” or “financial consultant.”

The Financial Planning Association and some consumer groups are in court in an effort to break you of that habit — and the issue will be coming to a head soon.

The FPA is suing the SEC to rescind a five-year-old rule, sometimes known as the “Merrill Lynch exemption,” that since 1999 has let broker/dealers blur the distinction between a stockbroker and a full-credentialed financial advisor. The FPA and planners they represent say the five years of inaction on the rule, while allowing b/ds to conduct themselves under it, is a violation of procedures and an abuse of SEC authority.

But it's the effects of the rule that are far more significant, they say, charging it has harmed the investing public and the credibility of the financial services industry by muddying the distinction between advisory and brokerage services. A commonly heard refrain among speakers at the FPA's recent gathering in Denver was this: “If it looks like a duck, waddles like a duck and quacks like a duck, should it be allowed to hang a sign around its neck that says ‘Goose?’”

Louis Harvey, president of Dalbar, a consulting firm in Boston, equates the b/ds' utilization of the rule to “regulatory arbitrage.” “It's absolutely insane to have different standards,” says Harvey. “At the end of the day, you have an advisor and a client. What is needed are some uniform rules.”

The SEC has treated the exemption as a rule since 1999, and the FPA hopes to force the SEC to resolve this situation through its suit. (It says it plans to act on this before 2005 — the comment period ended on Sept. 22.) While the FPA has figuratively broken out the torches and pitchforks, some believe that if any action is taken, it will be to knock the suit down or to affirm the exemption.

“This rule is not going away,” says Stephen Winks, a Richmond, Va.-based consultant who cites past remarks by the SEC to aggressively pursue those who breach their fiduciary duty.

The 1999 rule, “Certain Broker/Dealers Deemed Not to be Investment Advisers” was designed to address that while brokers weren't changing the nature of their business in the 1990s, the form of their compensation was already changing, from commissions to fees. Under the rule, b/ds that charged fees for services would be exempt from the Act if they abided by certain criteria:

  • The advice is provided on a nondiscretionary basis.

  • The advice is incidental to the brokerage services.

  • The b/d prominently discloses that fee-based accounts are brokerage accounts.

Problem is, planners say, brokers have been heavily marketing the advice aspect, conveying anything but the idea that advice is “incidental.” On every wirehouse Web site, the words “advice” and “financial planning” figure prominently. And the FPA contends that the “prominent disclosure” that the account is a brokerage account and not an advisory account is relegated to fine print.

The SEC was already aware of these representations, saying the advice-driven advertisements raise “troubling questions as to whether the advisory services are not (or will be perceived by investors not to be) incidental to the brokerage services.”

The SEC's original proposal was for a compromise — suggesting that one way to resolve the situation would be for those who have discretionary control over a client's account be subject to the 1940 Act, and those who don't have discretion would be exempt. It reopened the comment period on this tabled proposal on Aug. 18.

Michael Udoff, the associate general counsel for the SIA, insists the existing oversight structure of b/ds is superior to the 1940 Act. “Broker/dealers have a much more comprehensive regulatory framework that they're subject to,” he says. “Anyone looking at the respective oversight requirements would have to reach the same conclusion.”

Many reps think the dustup is less about the rule's fairness than about market share.

“They're bitter,” said one Smith Barney rep.

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