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News April 18, 2005 Issue

Fee-Based Brokerage Release Brings Issues Into Focus

The SEC’s 117-page fee-based brokerage release, posted on the SEC’s website last week, sheds a bit more light on issues raised during the Commission’s April 6 open meeting.

The IA/BD study. According to the release, within 90 days the SEC staff will prepare options and recommendations to the Commission about:

  • The scope of the study;
  • Appropriate persons, both within and outside the Commission, to be involved in the study; and
  • Timeframes for providing deliverables to the Commission, and for expected action by the Commission and its staff.

Based on the release, it seems that the NASD’s participation in the study is not a forgone conclusion.

Financial planning. The release also defines the line at which broker-dealers become financial planners, subject to Adviser Act regulation: If a broker-dealer holds itself out generally to the public as a financial planner or as providing financial planning services, delivers to the customer a financial plan, or represents to the customer that the advice is provided as pat of a financial plan or in connection with financial planning services, the Advisers Act is triggered.

So, for example, even a broker-dealer that does not advertise as being in the financial planning business will find itself subject to the Advisers Act the minute it hands over a financial plan to a customer. Even if not labeled as such, a document may be deemed a financial plan if it "bears the characteristics" of a plan, said the SEC. The Advisers Act, however, is not triggered merely by mentioning to a customer that financial planning services are available. The release does not discuss whether existing brokerage accounts that received past financial planning services are grandfathered from Advisers Act treatment.

While the SEC distinguished financial planning from traditional brokerage services, it acknowledged that elements of financial planning are, and should continue to be, a part of broker-dealer’s suitability analysis. "It would be unwise for us to distinguish when a suitability analysis ends and financial planning begins," said the SEC.

What’s in a name? The SEC did not impose limits on the use of terms like "financial advisor" or "financial consultant," currently used by some Wall Street firms to describe their registered representatives.

Discretionary brokerage accounts. The SEC agreed that brokers could take discretion on a "temporary or limited" basis, without causing the account to become subject to the Advisers Act. For example, a broker could be granted discretion for a period of months when the customer was on vacation or otherwise unavailable, or in situations when securities have to be bought or sold to meet margin call requirements.

Otherwise, however, the SEC stuck to its guns on treating discretionary brokerage accounts as advisory accounts. Interestingly, the SEC devoted several pages of the release to countering arguments set forth in a Morgan Lewis comment letter on that point.

Compliance dates. Compliance with the rule’s treatment of financial planning and discretionary brokerage accounts is required by October 24, 2005.

And the crowd roared . . . ? How does the Financial Planning Association feel about the rulemaking? "We are basically knee deep in reading through the published ruling," said FPA president Elizabeth Jetton. "Before we are prepared to comment on how we feel about it, we are trying to really read it and get 360 degrees around some of the statements and making sure we really understand the implications." She said that the group is trying to anticipate real life types of situations and how things would be handled under those circumstances. "Hopefully that will help us come to the right decision as to how to proceed," she said. "Overall, we are disappointed," she added. However, "we are at least quite happy that we’ve had an impact and drawn attention to some really critical issues that obviously the SEC felt this particular ruling was not prepared to address, so we’ll see where it goes from here."

Back in the day. History buffs will want to read the pages 17 to 25 of the release. In a painstakingly-researched study, the SEC traced the origins of the investment advisory industry from its earliest days when brokerage firm employees who dispensed advice were referred to as "customer’s men."

Overworked CCOs might smile at the 1940 testimony of SEC lawyer David Schenker, the architect of the Advisers Act. Appearing before the Senate Banking Committee, he urged lawmakers to enact the legislation, which at the time was viewed as little more than a census of the fledgling advisory industry: "All we want them to do," explained Schenker, "is file a registration statement which asks ‘What is your name and address, and have you ever been convicted of a crime?’"