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Proposed privacy rules rile small brokerage firms

Reg S-P changes are costly, burdensome and may provide little benefit, charge executives

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By Bruce Kelly

May 12, 2008 6:01 am ET

Small and independent-contractor brokerage firms are convinced that the SEC's proposed changes to privacy rules related to client information will crush them with new costs and burdensome procedures.

The Securities and Exchange Commission proposed the changes to Regulation S-P in March, and the deadline for broker-dealers and financial advisers to comment is today.

The proposed amendments to the regulation would create more-specific requirements for safeguarding client information and responding to information security breaches. They are also designed to align the rule's privacy guidelines more closely with those of the Federal Trade Commission and federal banking agencies, industry observers and attorneys noted.

The changes also would broaden the scope of the client information covered by the rule's safeguarding and disposal provisions.

The Financial Services Institute Inc. of Atlanta, which represents independent-contractor brokerage firms, sent a "call to action" e-mail to its members and their representatives last week urging them to submit comments to the SEC by today's deadline.

In its memorandum, the FSI said that the "proposed changes will create significant burdens for independent-broker-dealer firms and require the allocation of considerable re-sources by broker-dealers to review and revise existing privacy and data security policies and procedures."

Some small broker-dealers, also dismayed by the proposed changes, sent the SEC their comments.

"The change in regulations places additional training, record-keeping and supervision responsibilities on an already overburdened small firm," wrote Dave McNally, chief executive of McNally Financial Services Corp. of San Antonio.

"There seems to be no end to this bureaucratic virus that permeates all aspects of the financial industry. I can only assume that this is another attempt to eliminate small firms by overburdening them with regulatory requirements," Mr. McNally wrote.

The SEC's proposal regarding Reg S-P was "eerily similar" to a regulation regarding money laundering, another broker-dealer owner said.

"Are we doomed as broker-dealers to a regulatory environment whereby all of our functions must be managed within the framework of a comprehensive program?" asked James W. Millegan, chief executive of J.W. Millegan Inc. of Lake Oswego, Ore.

"Programs appear to be the new fashion in regulation with the SEC ... Once again, the proposed rules do not have any exceptions for small broker-dealers such as me," Mr. Millegan said. "This is going to be a costly and time-consuming en-deavor for very little return or protection to my customers."

One adviser asked the SEC for statistics and information before he could make his comments. Echoing comments of others in the industry, the adviser, Frank C. Dealy, wanted to know "the number of instances and the potential dollar amount of damages of breaches in customer privacy by small broker-dealers during the last one-year, five-year and 10-year period."

He is a registered rep with Brown & Brown Securities Inc. of Dallas as well as a registered investment adviser with Executive Advisors Inc. of Fairview, Texas.

"I am aware that banks lose their shirts through identity theft, but they are not regulated by the SEC. What is appropriate for banks may have no useful application for securities firms," Mr. Dealy wrote.

"From a small-firm perspective, I am looking for some documentation or statistics of actual customer personal information being obtained from broker-dealers or investment advisers on such a grand scale to warrant all the expense and effort to battle something that may not be a proved problem," he concluded.

Regulation S-P has been a hot-button issue for independent-contractor broker-dealers for almost three years. Last August, the SEC's division of enforcement moved to obtain a cease-and-desist order against Next Financial Group Inc. of Houston.

It slapped the firm with an administrative complaint over potential violations, the first step in a cease-and-desist proceeding,

The matter may have come to a head in December when an SEC administrative judge in Houston heard arguments from staff attorneys and Next Financial's lawyers about whether the firm had violated Regulation S-P when it recruited registered reps. (InvestmentNews, Jan. 14).

The judge has yet to issue a decision in the matter.

E-mail Bruce Kelly at bkelly@investmentnews.com.

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