(Money Management Executive)
The Securities and Exchange Commission has begun the process of studying the effects of a 2005 rule that lets broker-dealers offer clients advice along with products.
A lot of consumer protection is lost if advice comes from someone who is not an investment adviser, according to the rule’s opponents.
This month, the SEC issued a request for proposals to study the rule’s effects on investors, including whether it has confused them. Proposals were due today to undertake phase one — comparing the marketing, sales, fees, and product information offered by broker-dealers with those offered by investment advisers. The study is to include investors’ perception of these same matters.
“The study is an acknowledgement of the fact that there is no way you can disclose away investor confusion,” said Barbara Roper, the director of investor protection at the Consumer Federation of America in Washington.
A financial adviser by any other name is not at all the same, said Ms. Roper. The often interchangeable job titles, “planner, adviser, investment consultant,” blur the lines between the duties of these professionals to their clients, she said.
The Denver-based Financial Planning Association has filed a lawsuit in the District of Columbia Circuit Court of Appeals that argues similar points and calls the rule “arbitrary, capricious, and otherwise not in accordance with the law.” The law underlying the rule is the Investment Advisers Act of 1940, or IAA, which requires those who give paid advice to investors to act as their fiduciaries. Opponents argue that the 2005 rule perverts the spirit and the letter of this law.
“In updating the act to fit the congressional purpose it posits, the SEC also decides that because brokers are providing more and more investment advisory services Congress would want the IAA to cover less and less,” the FPA lawsuit asserts.
But most of the 1,700 comments on the rule before its adoption argued that the rule would invite product sales not in investors’ best interests because it allows brokers, who are not bound by the 1940 law, to provide, and charge for, advice to clients. This could encourage abusive sales practices, many commentators said. Fee-based services let broker-dealers earn steady revenue streams even when trading activity is low.
“They wrote investor protection off the books,” said Ms. Roper, calling the rule “arguably the most important issue out there for individual investors.”
It is also an important issue for financial planners and the fund companies who turn to them as distribution channels.
Investment advisers worry that the so-called “Merrill rule,” named for the giant brokerage that was among the companies lobbying hardest for it, will give large brokerage houses a huge advantage over them.
A Merrill Lynch & Co. spokesman declined to comment.
The Securities Industry Association, a Washington trade group that represents broker-dealers, has lauded the study’s launching. “This is an example of where the SEC is doing its homework,” said Travis Larson, a spokesman for the group.
Already, broker-dealers are required to include a disclaimer stating that their interests may not be the same as those of their investor clients. As blunt as it is, opponents of the rule call the disclaimer inadequate. Ms. Roper noted, however, that the request for study proposals from outside companies is “critical” since the rule interpretation that roused opposition came from in-house staff at the SEC.
But what happens to the rule once the study is complete?
Ms. Roper said she worries that the same staff that wrote the rule might be reluctant to unravel it, regardless of what the study says.
Reversing the rule thus could depend on the outcome of the FPA suit. “It will do just that, if we prevail,” said Neil Simon, the association’s head of government relations.
And that might be good news for some broker-dealers.
“Many of our members have been quietly rooting for the FPA suit to win,” said David Bellaire, the general counsel and director of government affairs at the Financial Services Institute. The Atlanta-based organization represents independent broker-dealers and has taken no formal position on the rule.
Independents found the rule, which allows incidental advice considered part and parcel of executing a transaction, too vague, Mr. Bellaire said. “In practical application, it’s very difficult to look at,” he said.
Some began searching for software packages to help them better devise investing models; others shied away from offering advice at all, fearful that they might accidentally break the law.
Unlike the FPA, Mr. Bellaire said, the Financial Services Institute does not want to see the rule wiped off the books. The institute would like it rewritten, he said, this time with his organization’s input. “Our members support clients’ having choices in how they pay for services,” he said. “Our organization supports disclosure as a way of dealing in general with any of these issues.”
The Security Industry Association’s Mr. Larson declined to make predictions, saying instead that the study would inform the SEC’s next move. “I think the study will go a long way in helping to answer some of these questions,” he said. “It’s something we’ll have to wait and see.”
