NEW YORK - With only three months to go before the implementation of the Securities and Exchange Commission's latest revision of the so-called Merrill Lynch rule of the Investment Advisers Act of 1940, compliance concerns are mounting among broker-dealers, especially independents.
The new rule, 202(a)(11)-1, spells out "when the investment advisory activities of a broker-dealer subject it to the Advisers Act."
Among the rule's key provisions are sharpening the definition of what exactly constitutes "solely incidental" advice to clients, including discretionary accounts, what type of financial planning tools a firm can use and how a firm "holds itself out" to the public.
Firms whose representatives provide services defined as financial planning under the new rule would be required to register those reps as investment advisers. The rule was first issued by the SEC in April, originally set to go into place last month, and now is set for Jan. 31, 2006.
But with the clock ticking, frustrated firms beginning to grapple with nitty-gritty compliance issues - and more than 100 pages of SEC explanation and example - say the new rule is bewildering and that compliance will be time-consuming, potentially costly and most likely hit or miss.
"There is significant confusion, and it is a challenge for us," said Valerie Brown, president of Atlanta-based ING Advisors Network Inc., the holding company for several broker-dealers around the country, including St. Cloud, Minn.-based PrimeVest Financial Services Inc. and Denver-based Multi-Financial Securities Corp. "The rule is trying to be a lot more definitive, but it does not make clear where suitability analysis ends and financial planning begins. It is very, very unclear, and the SEC has refused to draw the line."
"It's the most misunderstood [rule] in the brokerage community," said Terry Wallace, president and chief executive of Johnston Lemon & Co. Inc. in Washington. "There are very little guidelines."
According to one of the participants, similar frustration was voiced at the annual membership meeting of the Cornwall Bridge, Conn.-based National Society of Compliance Professionals held last month in Alexandria, Va.
"People are perplexed … but the SEC seems to be somewhat paralyzed at the moment," said Dave Campbell, a compliance consultant and president of the Nye Co. in Palo Alto, Calif. After one presentation about the new rule, he said, "30 or 40 of us just sat there looking at each other, wondering 'Now what do we do?' But there's no clear answer."
Although the SEC has not yet said it would provide additional guidelines for the new rule, there are indications that the commission may yield to industrywide demand for further elaboration before Jan. 31.
Those firms that have begun compliance procedures for 202(a) (11)-1 have found it formidable.
"The cost of compliance is astronomical," said Lynn Schmidt, president of Elgin, Ill.-based Meritus Financial Group Inc. "We're now in the process of documenting the increased cost."
The rule's increased scrutiny of discretionary brokerage accounts "caught us by surprise," said Laurie Lennox, chief compliance officer for Waltham, Mass.-based Commonwealth Financial Network. "We've had to act fairly quickly to change our policies," she said.
Some representatives, Ms. Lennox said, will have to relinquish discretion on their accounts, while others will be required to convert those accounts to investment advisory accounts. That "repapering" will come at considerable time and expense to the firm, she said.
A number of broker-dealers also are reconfiguring their financial planning software tools to comply with the rule, which draws a sharp distinction between "first tier" tools, such as questionnaires, which "meet the broker-dealer's suitability obligations," and "second tier" tools, which "offer comprehensive financial plans as a separate option, for a separate fee."
ING's broker-dealers, for example, had been using a software financial planning product called MoneyGuidePro as part of their workstation platform. Under the new rule, however, the company has determined that the software would be defined as a second-tier tool, requiring those accounts using it to be treated as advisory services under the Investment Advisers Act of 1940.
As a result, ING is working with the product's developer, Midlothian, Va.-based software company PIE Technologies Inc., to develop a software product that the rule would define as a first-tier tool.
"Understanding the difference between [the two tiers] is very murky," said ING's Ms. Brown. "A lot of reps are using tools they will not be allowed to use unless they have an advisory relationship with the client. But we do not want to discourage good analysis for suitability recommendations."
The software tool to accommodate broker-dealers who do not want to register as investment advisers tentatively will be called MoneyGuideBroker, according to PIE president and chief executive Bob Curtis, who counts dozens
of independent-brokerage firms among his clients.
The software, he said, will include "only those functions that are appropriately part of determining a client's suitability. We think you can still provide good suitability without crossing the line to what falls under the SEC's new financial planning definition."
The SEC rule also may force firms to change their sales and marketing strategies, said Keith Loveland, a compliance specialist who is a Minneapolis-based attorney and auditor, and president of Loveland Consulting. Some firms, he said, are considering splitting their sales forces between representatives and advisers.
And financial planners working inside of broker-dealers will have to "rethink how they represent themselves to the public.
"It's all about holding yourself out," Mr. Loveland emphasized.
"I don't think anyone is happy with the new rule," said Nancy Lininger, a compliance consultant and founder of The Consortium in Camarillo, Calif. "Fee-only advisers feel this is a poorly conceived rule and that broker-dealers can tread into their territory without being RIAs and without being deemed a fiduciary. Broker-dealers feel they are more constricted than before in that they cannot provide financial planning tools, nor provide discretionary accounts, without being deemed to be an RIA. There are lots of concerns, confusion and frustrations."