Are Reps Advisors or Mere Brokers?

The latest move to influence the SEC’s much awaited decision on the fate of the proposed “broker-dealer exemption rule” came today from the Consumer Federation of America, a nonprofit association representing 50 million Americans in 300 different consumer groups. The CFA sent a comment letter to Chairman Donaldson, suggesting the nature of the services, not the compensation model, is what is important. And the current exemption misses this point.

The latest move to influence the SEC’s much awaited decision on the fate of the proposed “broker-dealer exemption rule” came today from the Consumer Federation of America, a nonprofit association representing 50 million Americans in 300 different consumer groups. The CFA sent a comment letter to Chairman Donaldson, suggesting the nature of the services, not the compensation model, is what is important. And the current exemption misses this point.

The CFA letter is a rebuttal to the SIA comment letter that said the rule’s continued existence was necessary to the health of the industry and investors.

With just over two-and-a-half months left in the year, the SEC’s pledge to deal with the proposed rule, which is formally called, “Certain Broker-Dealers Deemed Not to be Investment Advisers”, before the year is out is getting closer.

Proposed in 1999 by the SEC, the rule was meant to reflect the changing pricing structure—but not the nature of the services provided—at many full-service brokerages, from commissions to fees. Never formally adopted or given a full comment period then, the so-called “Merrill Exemption” rule has nonetheless been allowed to exist and has protected registered reps who charge fees for service from regulation as fiduciaries under the Investment Adviser Act of 1940.

The SIA, in its comment letter, fully supports the adoption of the rule and says it provides a valuable choice for investors for how they pay their brokers. The nearly $200 billion—and rising—in investor assets in fee-based accounts confirms they appreciate the choice, says the SIA. Mike Udoff, the vice president and associate general counsel at the SIA, says that choice is at the heart of the rule. “We can respectfully agree or disagree about what the ‘incidental advice’ should be or who has the better regulatory framework [reps or registered advisors], but at the end of the day, we [the CFA and the SIA] agree that the form of compensation should not reflect the applicability of the Adviser’s Act,” says Udoff, “And that’s all the rule pertains to.”

The CFA agrees that compensation alone shouldn’t determine regulation, but says in its letter to Donaldson that this is precisely the rule’s main flaw. “The main shortcoming of the rule is that it tackles the wrong problem,” writes Barbara Roper, the president of the CFA and author of the letter. She says focusing on compensation, instead of the nature of the services provided is wrong.

“Congress intended that the nature of the services provided would determine the nature of the regulation,” writes Roper. Many in the industry, including the Financial Planning Association, say the nature of traditional brokerage services have changed in the past few years at full-service firms from mere buy-and-sell to full-on advice, all the while still being exempt from 1940 Act regulation. Wirehouses using the words “financial planning” and “advice” heavily in their marketing literature have caused many critics to ask: Are these services, that are supposed to be incidental, being billed as central to the practice? The CFA asserts that the Commission’s “approach of allowing brokers to offer virtually unlimited advice without triggering the Advisers Act regulation…has been primarily responsible for erasing the distinction between brokerage and advisory services.”

And how do you determine the nature of the services provided?

The CFA says the SEC first needs to concretely define “solely incidental to the practice,” one of the caveats that refers to the kind of advice registered reps can give and still be protected from regulation under the Advisers Act. Roper offers no suggestions of how to define this in the letter, other than reminding the SEC that the original intention of Congress was “only a very narrow exclusion for the kind of ‘buy this, sell that’ recommendations that are an integral part of the broker’s primary business.”

After it has defined this pivotal phrase, the CFA says the SEC should “conduct a thorough study of the services being offered by brokers to determine which are truly brokerage services, and which ought to be regulated as advisory services.”

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