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One more time: Retail investors your clients are confused about the definition of a financial advisor. That is, they don't understand the difference between a Series 7 registered representative and a Series 65 investment advisor representative even when the differences are explained to them in plain language. So says an SEC-commissioned survey. Fiduciary duty? Suitability standard? It's all the same

One more time: Retail investors — your clients — are confused about the definition of a financial advisor. That is, they don't understand the difference between a Series 7 registered representative and a Series 65 investment advisor representative — even when the differences are explained to them in “plain language.” So says an SEC-commissioned survey. Fiduciary duty? Suitability standard? It's all the same to them.

Of course, you are still required to explain the legal nature of your relationship to clients, even if it means burying clients with disclosures (which the survey says clients generally don't take the time to read). As far as they are concerned, you are “The Man” — the trusted advisor — and they tend to defer to your judgment when it comes to their financial lives. That's what they pay you for, after all.

So what's the problem? It sounds like pretty good news, right? That same SEC-sponsored survey, released in January, found that “most respondents and focus-group participants are happy with their own financial-service providers,” whatever their financial returns. Why? Because “trustworthiness” and “personal service” were prized more than “expertise or performance,” says the report, conducted by The Rand Corp., a non-profit, quasi-governmental research house. (Congratulations on the strong customer-satisfaction rating, by the way.)

The problem is twofold: Clients actually need to understand what they're getting and paying for, and the money and labor that firms and their advisors spend serving two separate regulatory regimes — established around the time of the Great Depression — don't ultimately benefit the customer, or you.

“The fact is the business models of brokers and investment advisers have converged,” says Hardy Callcott, a partner with law firm Bingham McCutcheon whose practice focuses on securities-industry regulatory issues. “But they're regulated in different ways. Nobody would defend that as the best solution today.”


While the Rand report stopped short of making any policy recommendations, the writing is on the wall. It's time to change the two outdated laws to create what is, essentially, a single profession. Christopher Cox, the chairman of the SEC, heads to Capitol Hill during the session of the 110th Congress this year. He should recommend that the Securities Exchange Act of 1934 and the Investment Advisers Act of 1940 be rewritten (or, “harmonized,” as one lawyer put it) to reflect reality. The fact is: The differences between registered reps (Series 7 holders regulated by the 1934 Act) and registered investment advisors (regulated by the 1940 Act) have largely evaporated. According to the Rand report, “Trends in the financial-service market since the early 1990s have blurred the boundaries between [broker/dealers and RIAs]. Firms are constantly evolving, and bundling diverse products and services in response to market demands and the regulatory environment.” (See the “Investor and Industry Perspectives On Investment Advisers And Broker-Dealers,” at

The question is how should the laws be rewritten? What is the solution? By June 1, Cox is to receive recommendations on this very topic from SEC staff. (They declined to comment on what form these recommendations might take.) But of course, the SEC won't be able to change much without Congress' intervention. Unfortunately, that's not likely to happen during an election year.

Still, Congress should move this issue to the top of the list. Further tweaking by the SEC won't work. The SEC already tried that in 1999 when it issued the broker/dealer exemption (the “Merrill Lynch rule”), which allowed reps to offer fee-based advice on brokerage accounts, given certain stipulations. Industry wide, some $300 billion went into these fee-based brokerage accounts, further muddling the legal definitions of the two types of financial professionals. At least, that's what the Financial Planning Association argued successfully before a D.C. Court of Appeals last year. (The Court then vacated the exemption, giving b/ds time to move the $300 billion in question into either RIA-like advisory accounts, or regular brokerage accounts). That court decision gave the SEC the opportunity to resume brainstorming a real solution.

Should Congress demand that all financial advisors — including reps with commission-based books — take on fiduciary duty? Or should we return to another era, and require registered reps to stop calling themselves “financial advisors” or “financial consultants” on their business cards, forcing them to revert back to stockbrokers? The latter is a non-starter, since the Rand report has already established that the investing public doesn't distinguish between b/d reps and advisors of RIAs.

The definitions may not mean much to clients, but b/ds say they have real ramifications for the investment choices available to your clients. These legal definitions also impact the way you conduct your day-to-day business, and how you, and your firm, keep business records. Dually registered advisors — holding both Series 7 and IAR licenses — have to answer to two separate regulators: the SEC and FINRA. This means they have to juggle multiple sets of inconsistent rules, as well as in-state requirements. For them, compliance chiefs say, having to adhere to the different statutes creates redundancies and inefficiencies in doing business.

“One example is the books-and-records requirements,” says Callcott. “There's one set of books and records rules under the IA Act, and another for broker/dealers. It's very expensive, and frankly, I don't think there's any customer-protection benefit from it,” he says.

For that reason, some dually registered advisors choose to drop their Series 7, says Paul Tolley, chief compliance officer of the Commonwealth Financial Network. “Some rules are redundant, some overlap and some are completely different,” he says. “For a dual registrant, it is complex at best.” For that reason, his firm expects dually registered advisors to continue dropping the 7 license. He adds, “FINRA is harder to deal with sometimes; it's more stringent than for RIAs.” RIAs can go up to five years before being audited by the SEC; FINRA conducts an audit every two years.

Tolley is very familiar with the compliance headaches wrought by dual registration. Commonwealth is an independent broker/dealer and an RIA, and 1,300 of its 1,400 FAs are dually licensed. Interestingly, while other b/ds rushed to take advantage of the broker/dealer exemption, Commonwealth stayed true to the letter of the original federal statutes. It never permitted its commission-based reps to act like advisors: It never created or sold fee-based brokerage accounts. “We've always felt that if you are going to offer a fee-based advisory account, you should do so as a fiduciary,” Tolley says.


Sallie Krawcheck, the head of Citi Global Wealth Management, says the ruling to vacate the broker/dealer exemption is a huge opportunity for the big Wall Street firms. At the SIFMA annual meeting last fall, Krawcheck predicted, “The FPA won the battle, but will lose the war.” Simply put, she expects the ruling will force Wall Street brokerages to adopt the financial-planning business model more completely — making the big Wall Street brokerages more formidable competitors for financial planners (many of which are mom-and-pop businesses). That may not be something a lot of financial planners really want. Certainly, firms with lots of dually registered reps are well positioned. (For example, of the roughly 14,000 Smith Barney reps, about 8,500 are also IARs.)

There's one catch: The big broker/dealers engage in principal trading and other “prohibited” transactions, something that registered investment advisors cannot perform under the IA Act of 1940 and ERISA (the Employee Retirement Income Security Act of 1974).

In other words, Wall Street firms, and advisors, who convert certain accounts to the investment advisory model (which are then regulated by the IA Act) must stop selling clients securities that are held in inventory by their firms, such as preferred stock, convertible debt, CDs, municipal bonds, unit investment trusts and government agency bonds. The SEC issued an interim rule this past September, effective until September 30, 2009, that is meant to give dual-registrant firms like the wirehouses some relief from such restrictions. But SIFMA says it doesn't go far enough. After that date, clients of big firms who do principal trading, then, must have two accounts — a brokerage and an RIA account — if they want to hold many popular individual securities. And that can be a major hassle.

“Many of these instruments are attractive to retail advisory clients because they can offer higher yields but with a lower risk of loss than investments such as common equity,” writes SIFMA General Counsel, Ira Hammerman, in a letter to the SEC urging it to expand the current limitations.

And therein lies the problem. Wall Street needs Congress to change the rules. Where fee-based brokerage accounts afforded near-limitless investment options for clients, non-discretionary advisory accounts at b/ds are severely limited in the kinds of products they can offer clients. Also, with fee-based brokerage accounts, reps could engage in principal transactions with clients without having to comply with the notice and consent rules of the Advisers Act. Now that such clients' assets are held in advisory accounts, the reps don't have that option.

“The issue is client choice,” says Dan Sontag, head of Merrill Lynch's Americas client relationship group. “In fee-based brokerage accounts, clients could do a lot of different types of investing,” he says. Sontag says he had a fee-based brokerage account but has moved his money into two accounts — a Merrill Lynch Personal Advisor (MLPA) account, the firm's non-discretionary fee-based advisory offering, and a regular brokerage account. It's a solution he says a lot of advisors are providing for clients, so that they can get access to products unavailable in the non-discretionary advisory account.

The Financial Planning Association, with its 28,500 financial planner members, remains skeptical about relaxing principal trading restrictions any further in retail accounts. The worry, the FPA says, is that retail accounts will be abused: “If, as it has been asserted [by SIFMA in a letter to the SEC that] … principal trades are a significant benefit for a firm's retail customers, then we recommend that the Commission track principal trading activity in retail … as well as institutional accounts. The purpose is to determine if there is any unusual bias towards principal trading in retail customer accounts.”

That isn't the only sticking point. Tolley, the Commonwealth compliance chief, says, yes, the federal securities laws could use an overhaul. But the 50 states' securities laws are an equal burden, since each of the states has different rules and regulations. “I'd love to see more uniform laws with the states,” he says, although he notes that most states have adopted many of the 1940 IA Act rules. Still, conforming to the “state rules is incredibly difficult and inefficient.” The goal of a firm should be to apply the right rules to the right situations. But, unfortunately, sometimes, “The most strict and restrictive [state] rules are applied [by the firm] to everybody, and used in all states.” That's not the best way to conduct business or make securities laws, he says. “We try not to do that, but it's a reality that firms sometimes can't help it.”

Why not just make everyone a financial advisor with fiduciary duty? Tolley also questions that solution, since it would pose serious problems for reps who run commission-based books of business. People can talk about the beauty of the fee-based model all they want, he says, but there is a place in the world — a genuine need from some clients — for simple pay-as-you-go financial advisors. “Can you imagine the plaintiffs' lawyers? They're always arguing that advisors have a fiduciary duty,” he says, because it's easier to successfully litigate. “On the commission side, how do you apply a fiduciary standard when an advisor's compensation is directly tied to the product sale? Plaintiffs attorneys are salivating over that.” That's because the sale of a variable annuity, say, might be offered at a cheaper price somewhere in the world, and that would run against the fiduciary standard, he explains. “It is always easy to determine if something is cheaper for a client, but it can be hard to decide if something is better for a client.”

SEC staff lawyers may recommend another solution to the problem. Chairman Cox promises to create a “roadmap” once the staff has made its recommendations. Those who are hoping for real change are not holding their breath. “We have limited expectations,” says Duane Thompson, of the SEC's ability to produce substantive change in response to the Rand study. He points to the lack of clarity regarding financial planning, an area the SEC has not fully defined. Thompson would also like the confusion over titles cleared up. “The SEC has said it's not okay for brokers to call themselves financial planners, but it's fine for them to call themselves financial advisors. If you're an investor, is that confusing or not?” he says.

Callcott's law firm expected clarification from the SEC regarding financial-planning definitions in September's Interim rule. Without it, firms are confused, too. “As a result, there remains considerable uncertainty about whether a broker/dealer may produce a financial plan for brokerage account customers,” the firm writes in a note on its website.

“The solution is Congressional overhaul,” says Ropes & Grey attorney Richard Marshall. “The public doesn't grab a bunch of statutes and sort out which pigeon hole they're jumping into when they go see a broker or an investment adviser,” he says. “It's a common sense decision.”

Marshall, like Callcott and others, says any Congressional action should reflect what the Rand study found: The public wants, and expects, the same things from them. He mentions the FSA, Britain's Financial Services Authority, which was created in 1996 in the interest of developing uniform regulation for all financial entities. Before that, says Marshall, they were operating in a system “far more archaic than ours.” He says the creation of one regulator has removed “a lot of the political screaming” in the British system. But whether the answer is a different model altogether, or just a new version of the old statutes, the industry is looking for guidance.


Rep-as-advisor programs, otherwise known as non-discretionary advisory programs, are growing rapidly. ($ billions)

2001 2006 2Q'07 4Q'07 6-Year CAGR
Separate-account consultant programs $421.9 $739.8 $808.1 $814.2 11.6%
Mutual-fund-advisory programs 134.9 399.6 478.8 526.5 25.5
Rep-as-portfolio manager programs 69.7 182.7 211.6 245.3 23.3
Rep-as-advisor programs 20.1 94.6 123.0 321.4 100.0
Fee-based brokerage programs 146.6 275.9 276.5 N/A N/A
Unified managed-account programs N/A 27.4 32.4 35.5 N/A
Total managed-account programs 793.2 1,720.0 1,930.4 1,942.9 16.1
Source: Cerulli Associates
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