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News October 2, 2006 Issue

SEC Selects RAND to Conduct IA/BD Study

The SEC received twelve submissions in response to its August 1 request for proposal on the IA/BD study.

It picked the RAND Center for Corporate Ethics, Law, and Governance.

Technically speaking, itís the "LRN-RAND Center for Corporate Ethics, Law and Governance." The center was formed in 2004 as a result of a strategic alliance between RAND and LRN, a Los-Angeles based consulting firm that provides legal, compliance, ethics management, and corporate governance services. According to a RAND spokesperson, the SECís September 26 press release appears to have mistakenly omitted "LRN" from the centerís official title.

In any event, the study is now officially underway. In order to compare how different regulatory systems governing broker-dealers and investment advisers affect investors, RAND will collect and analyze empirical data and study the ways brokers and advisers market, sell, and deliver financial products and services to individual investors.

Among other things, RAND will:

  • interview representatives of industry groups, regulators, and investor advocates;
  • read up on relevant economic and business literature;
  • collect relevant business documents;
  • interview representatives of BD and IA firms;
  • conduct investor focus group interviews; and
  • summarize and evaluate the data for the SEC.

"Our goal is improved investor protection through updated SEC regulations that deal with the realities of todayís marketplace," said Chairman Christopher Cox. "The study will develop the best available information, from inside and outside of the Commission, to inform this important process."

The study was a frequent topic of discussion at last weekís IA Week conference. Division of Investment Management director Andrew Donohue noted that the information will help the SEC assess how the IA and BD regulatory schemes impact not only investors, but firms as well. "This is an exciting process and a worthwhile endeavor," said Donohue, who expressed hope that the study would "further the dialogue on these important issues."

SEC Commissioner Annette Nazareth devoted her entire luncheon address to the topic. She emphasized that the SEC has long taken the view that brokers legitimately provide investment advice, noting that the Commission has determined that advice is incidental to brokerage when it is provided "in connection with and reasonably related to" brokerage. That, she said, "is a broad standard" and is not limited to "providing advice relating only to transactions or when the advice is minor in scope or importance." This, she said, makes "good sense" from a policy perspective. "Broker-dealers should be incented to provide the highest-quality of investment advice they can, without the risk that doing so will subject them to another, arguably largely duplicative regulatory regime," said Nazareth. "Our goal should be to motivate broker-dealers to maintain the highest industry standards in the provision of advice."

The Tully report, she said, concluded that "advice-giving is the most important role of a broker-dealer."

Nazareth noted that the Exchange Act and the Advisers Act have different focal points: The Exchange Act, she said, "is primarily concerned with regulating the entire relationship between the broker and its customers." In contrast, the Advisers Act "is focused on advice." However, the regulatory regimes "are two different means of arriving at the same end," namely, investor protection. "To the extent that there are differences in the application of the two regulatory regimes, I believe that the IA/BD study presents an opportunity for the Commission to fill in the gaps."

Industry commenters, however, offered a somewhat different perspective.

Wilmer Hale partner Marianne Smythe noted that the "tectonic plates" of the brokerage and advisory business have been moving together, at least at the retail level. Brokerage firm reps, she said, "call themselves financial advisors with an Ďoí and youíre supposed to know that this person is not an investment adviser." In her view, "when you get to that level of absurdity, you just know that there is a mixing of functions in the retail space that is unprecedented, really."

Despite that, Smythe expressed her opinion that the IA/BD study is not needed. "This issue has been coming now for about the past twenty years. Itís not new," she said. "They donít really need to do this study to know what the data is. The data is that every large firm has reps who are in the financial planning [and] investment advisory [space], but also in the selling/broker-dealer space. What they need to do is to figure out whether there need to be changes in the laws."

She expressed doubt that regulators will take action. "Itís hard for me to see absent a crisis that in the end there will be any real change," she said. "From my perspective, this is just a whole lot of fuss and feathers. They donít need a study. There is, in fact, a reality that the people who are giving investment advice are also selling products. There are plenty of laws on the books already to address those issues. And I donít really understand why we are doing all this."

Former SEC commissioner Richard Roberts predicted that Congress might be willing to pick up the issue, but only if the SEC presents a legislative package. Congress is "gun-shy, just like everyone else," said Roberts, himself a former Capitol Hill staffer. "They are not going to act unless they have a definite recommendation on the table." A legislative package that blends the current approaches to IA and BD regulation in an effort to end up with a more efficient regulatory model "would be well received" and "would be probably pretty easy for Congress to do," he said. However, he noted, "getting that ball rolling is very, very difficult." The SEC "would need to be aggressive about it, and I just think they are preoccupied with other things" And, he noted, "everybody knows what a study means in Washington. You donít kill it, you study it."

Mayer, Brown, Rowe & Mawe partner Kathie McGrath said that the IA/BD study should encompass other financial service providers that provide advisory services, such as banks and thrifts. "If they are going do it right, they probably ought to look at what [IAs and BDs] can do and what a [savings and loan] can do and try to impose the same roles on the conduct, not the entity," she said. Regardless of the outcome of the IA/BD study, added McGrath, "it still wouldnít make sense unless they bring under this system the folks who are doing the same damn thing" in other types of financial institutions.