To appeal or not to appeal

May 14, 2007 @ 7:35 am

By Sara Hansard

WASHINGTON — With the deadline bearing down to initiate legal action to block a federal court’s decision on the legality of fee-based brokerage accounts, the brokerage industry is looking for guidance on how to proceed.

The Securities and Exchange Commission has until today to appeal a March 30 ruling by the U.S. Court of Appeals for the District of Columbia Circuit that it overstepped its authority by allowing registered reps to hold themselves out as investment advisers, without requiring them to act as fiduciaries — provided that any advice they dispense is “incidental.”

If no appeal is filed, the ruling will go into effect May 21.

If an appeal is filed, implementation of the ruling likely will be delayed for months as the case makes its way through the courts.

Although the SEC reportedly is leaning against an appeal, SEC Chairman Christopher Cox is playing his cards close to the vest.

The SEC is “working through all of the issues and the practical concerns,” he said Thursday after speaking at a gathering of mutual fund industry executives in Washington. “Our decisions on whether to appeal are normally based on the technical, legal question of probability of success on the merits.”

In the meantime, the brokerage industry is scratching its head over what to do with the nearly $300 billion sitting in non-managed fee-based brokerage accounts.

“This is all about a rule that the SEC put in place” and which the brokerage industry has been following in good faith, said Ira Hammerman, senior managing director and general counsel of the Securities Industry and Financial Markets Association, based in Washington and New York.

“Those accounts need protection,” Mr. Hammerman said. “Those customers want to have a brokerage relationship, and we’re hopeful that the SEC will find a way for that to continue.”

Applying pressure

SIFMA, which represents more than 650 securities firms, has urged the SEC to appeal the decision, arguing that it could hurt about one million investors with fee-based accounts at brokerage firms.

Last Wednesday, the group turned up the pressure by releasing the results of a telephone survey of 483 investors that found that 82% of those surveyed agreed that they should be able to choose how to pay for services related to their accounts — either through transaction fees or annual fees.

SIFMA is not the only entity looking for direction from the SEC.

Last Tuesday, UBS Wealth Management US in Weehawken, N.J., held a telephone conference call with many of its 8,000 brokers during which the possibility of scrapping its fee-based brokerage was raised.

“We have not made any decision as to what to do,” said Karina Byrne, a spokeswoman for UBS, a unit of UBS AG of Zurich, Switzerland. “We’re waiting for guidance from the SEC.”

At yearend, $30 billion resided in UBS’s fee-based program, which is called InsightOne, according to research firm Cerulli Associates Inc. of Boston.

If UBS decides to shutter InsightOne, it would likely transition many of the assets in the program into accounts belonging to one of its other fee-based advisory programs, which include Strategic Advisor and ACCESS.

Does that mean that some UBS brokers would lose those assets?

“In theory, yes,” Ms. Byrne

said. “Not all of them can act as fiduciaries.”

Tough act to follow

One of the biggest difficulties for brokerage firms, in trying to adhere to adviser standards, is a prohibition in the Investment Advisers Act of 1940 against registered investment advisers selling securities that are owned by the brokerage firm, a practice known as principal trades, a mainstay of the brokerage business

“Operationally, if you’re an adviser, you can’t do principal trades without a waiver for each trade individually,” said Morris Armstrong, principal of Armstrong Financial Strategies, an investment advisory firm in Danbury, Conn. “That would become an operational nightmare.”

That issue should be dealt with as a separate issue by the SEC, said Daniel Moisand, a principal with Melbourne, Fla., investment advisory firm Spraker Fitzgerald Tamayo & Moisand LLC.

“If that is indeed the primary issue keeping brokers from registering as investment advisers, let’s focus in on that and see if we can come up with something better,” Mr. Moisand said.

“Let’s restrict the rulemaking to that issue and see if we can come up with a rule that may make it less cumbersome,” he said.

However, Mr. Moisand also is wary of selling clients securities owned by a firm that is providing advice to the client. “To say we need an exemption so that we can get our clients to do something they wouldn’t do if they knew what they were doing is not a good argument,” he said.

In 1999, the former Securities Industry Association drew stiff opposition from the mutual fund industry as well as from the SEC when it proposed changing the provision of the Investment Advisers Act that prohibits brokerage firms from selling their own securities to their mutual fund arms (InvestmentNews, May 17, 1999).

Beyond that immediate issue for brokers who provide advice to clients is whether firms should continue to be allowed to be registered as both brokerage firms and investment advisory firms, some advisers say.

“There’s an inherent absurdity in allowing people to fall back on a lower standard of care when it’s convenient for them,” said Steven Weydert, executive vice president of investment advisory firm Bowyer Weydert Wealth Planning Partners Inc. of Park Ridge, Ill.

Other advisers hope that investor education will increase as a result of the case.

“What I would hope to see come from this is just public awareness to let [investors] know there is a difference,” between brokers and advisers, said Jeremy Portnoff, president of Portnoff Financial LLC in Piscataway, N.J.


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