A Monster Issue

It seems so trivial, just a turn of phrase: Can Series 7 stockbrokers bill themselves as financial advisors without getting a Series 66, the license that technically separates advisors from salesmen? Since 1999, brokers have been able to do just that, thanks to the SEC's Broker-Dealer Exemption also known as the Merrill Lynch exemption a temporary measure originally aimed at curbing churning and other

It seems so trivial, just a turn of phrase: Can Series 7 stockbrokers bill themselves as “financial advisors” without getting a Series 66, the license that technically separates advisors from salesmen? Since 1999, brokers have been able to do just that, thanks to the SEC's “Broker-Dealer Exemption” — also known as the Merrill Lynch exemption — a temporary measure originally aimed at curbing churning and other abuses of the commission-based culture.

The SEC has been slow to issue a more permanent ruling, in part because the explosion of fee-based business has made rescinding the Merrill Lynch exemption a more momentous decision with each passing year. The agency is preparing to act, and its decision — expected by April 15 — is the regulatory monster under the bed. If reps must back away from advisor status now, says Bill Singer, a securities industry lawyer at Gusrae Kaplan & Bruno, it will throw the wirehouses into chaos, at least temporarily.

That's because fee-based accounts currently handled by Series 7 holders would have to be handed over to advisors with the proper certification — at least until the brokers could acquire Series 66s. (Despite repeated attempts, none of the wirehouses contacted for this story returned calls by press time.) “It's a very dangerous decision for the industry,” Singer says.

If the exemption is withdrawn, “the impact would cause substantial disruption in the markets,” says Giovanni Prezioso, general counsel for the SEC. Nonetheless, the FPA is leaning hard on the SEC to rectify what it views as an injustice to financial advisors and investors alike. The 1999 exemption lets brokers who meet three criteria refer to themselves as “advisors,” as long as:

  • The advice provided is on a nondiscretionary basis.

  • The advice is solely incidental to the brokerage services.

  • The broker/dealer prominently discloses that the account is a brokerage account.

The FPA and consumer groups like the AARP and the Consumer Federation of America say b/ds have taken advantage of the language of the last two criteria. The groups note that firms' marketing and advertising campaigns are filled with phrases like “comprehensive advisory services” and “financial planning,” blurring what they say should be a hard-line distinction between advice-givers (advisors) and salesmen (brokers).

The FPA believes this misrepresentation comes at the expense of licensed advisors — those fee-only RIAs who must act as fiduciaries as stipulated by the Investment Advisers Act of 1940.

In July, the FPA filed a suit to force the SEC to take action. And it did so, in a manner of speaking, passing in December a new temporary rule that extends the old one (with a few twists) while it gathers comments on a proposed permanent measure (viewable at sec.gov/rules/final/34-50979.htm). The deadline for comments is Feb. 5, and the SEC is slated to adopt some version of the exemption or remove it altogether by April 15.

There is evidence that the SEC regrets having let this issue languish. “The commission has allowed the years to while away without taking any action,” lamented SEC commissioner Paul Atkins at an SEC meeting last December. “Only litigation has awakened us and forced us to act.”

Still, the SEC does not seem inclined to act hastily. Given the detailed nature of the 101-page proposal, the SEC can expect a deluge of comments. In fact, the SEC explicitly requests public comment throughout the pages of the new temporary rule. They received over 1,700 comments on the original query.

One matter that is on the table: The current temporary rule requires brokerage disclosure statements to identify a person at the firm who can walk clients through the differences between a brokerage account and an advisory account. Also up for consideration is whether brokers should be able to continue to call themselves “financial advisors” or “financial consultants” and still be exempt from the regulation of the 1940 Advisers Act. “The sort of line-drawing we're talking about here is very difficult,” said Prezioso in the December meeting.

The FPA and its supporters realize this, but they also maintain that the time has come to get off the fence on this important issue. “Before the lawsuit this was pretty much considered a backwater issue,” said Duane Thompson, the FPA's director of government relations. “Now they realize how long it's been out of the fridge, and that not only does it stink, it's been stinking for a while.”

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