Court rejects broker-dealer exemption rule

WASHINGTON — The U.S. Court of Appeals for the District of Columbia Circuit on Friday overturned the Securities and Exchange Commission’s broker-dealer exemption rule in a 2-1 decision.
The decision is a victory for the Financial Planning Association, which sued the SEC in 2004, challenging the commission’s original rule proposal, which was issued in 1999 but never finalized. That led to the SEC modifying the rule several times, finalizing it in 2005.
The Denver-based FPA continued its challenge.
“This rule should have died a quick and merciful death … years ago,” FPA president Nicholas A. Nicolette said in a prepared statement.
“It would not be the best use of taxpayer dollars to prolong a policy that is contrary to the public interest,” added Mr. Nicolette, who also is the principal of Sparta, N.J.-based Sterling Financial Group.
Others agreed.
“The broker-dealer exemption was wrong,” said J. Thomas Bradley Jr., president of TD Ameritrade Institutional of Jersey City, N.J., who has stood out among brokerage executives by voicing his opposition to the rule. “I hope no one tries to wiggle out of it. We all need to suck it up.”
Many advisers also cheered the ruling, which marks the latest twist in the industry’s battle over the distinction between brokers and financial advisers.
“I think this is great news,” said Bernard Kiely, a fee-only certified financial planner who is owner and president of Kiely Capital Management Inc. in Morristown, N.J. “The consumer has had a very hard time finding out who the sheep are and who the wolves are.”
The broker-dealer exemption rule, which went into effect last year, allows registered reps to hold themselves out as financial advisers without being required to act as a fiduciary — provided any advice they dispense is “incidental.” In other words, it exempts some brokers from being regulated as advisers, even if they charge fees based on assets.
To be sure, not everyone was pleased with the ruling.
“I think it’s insane,” said Arthur F. Grant, chief executive of Cadaret Grant & Co. Inc. in Syracuse, N.Y.
In a free market, broker-dealers should be allowed to charge clients a fee or a commission, he said.
In the ruling, Judge Judith Rogers wrote that the SEC exceeded its authority by exempting brokerage firms that charge asset-based fees from regulation under the Investment Advisers Act of 1940.
“The rule is inconsistent with the IAA,” she said in the ruling, because it fails to meet the law’s requirements for exemptions. Under that law, Ms. Rogers said, brokers can be exempt from advisory regulation only if they don’t receive “special compensation” for giving advice.
Charging asset-based fees means registering as advisers, she said. “No … indicators of congressional intent support the SEC’s interpretation of its authority,” Ms. Rogers said.
“We will analyze the opinion and proceed appropriately in investors’ best interests,” SEC spokesman John Nester wrote in an e-mail.
In a dissenting opinion, Judge Merrick Garland said that the SEC’s interpretation of the IAA was reasonable and that courts are bound by legal precedent to give government regulators the benefit of the doubt in interpreting the law.
The brokerage industry, as represented by the Securities Industry and Financial Markets Association of New York and Washington, offered a measured reaction to the news, saying in a prepared statement that some “regulatory uncertainty will exist until new rules are promulgated. SIFMA will continue to closely monitor developments and work with regulators and members to resolve this issue.”
In addition, SIFMA’s highest priority now “is ensuring there is no disruption to our customers while we wait for the SEC to provide interim guidance which conforms to the ruling,” Ira Hammerman, the association’s general counsel, said in a prepared statement. “In the meantime, we encourage firms affected by today’s verdict to comply with the decision while simultaneously working to provide customers as much disclosure as is reasonable, given the ruling.”
One registered rep, who also is a registered investment adviser, stood up and applauded when he heard of the decision, he said.
“I’m thrilled, but if I were the president of a broker-dealer, I might be less than thrilled, because it could make my life more complicated,” said Malcolm A. Makin, president of Professional Planning Group of Westerly, R.I. The ruling could push up costs to broker-dealers who provide their reps with investment advisory services, said Mr. Makin, whose firm has about $650 million in assets, close to 85% of which are fee-based.
Other industry participants weighed in on the court’s decision.
The ruling is “very straightforward” and a “clean decision,” said David Tittsworth, executive director of the Investment Advisers Association in Washington. “This is throwing the rule out.”
The ruling opens the door for Congress to re-examine securities laws in light of changes that have taken place in the industry since those laws were enacted during the Great Depression.
“It looks to me like Congress probably will need to get into this fray to sort it out,” Mr. Tittsworth said.
Indeed, the prospect of Congressional intervention shouldn’t be ruled out, said Richard Bellmer, chairman of the Arlington Heights, Ill.-based National Association of Personal Financial Advisors.
“They’ll either appeal, or it wouldn’t surprise me if they go to Congress and try to get a new law passed,” he said of the brokerage industry’s likely next step.
The ruling is “very good news for consumers,” added Mr. Bellmer, who also is a partner at Deerfield Financial Advisors Inc. in Indianapolis, which oversees $300 million in assets.
Charles R. Harr, a CFP at Patriot Investment Management in Knox-ville, Tenn., was pleased — and surprised — by the ruling. “It looked like it would go the other way,” he said. “It appeared to us that the FPA efforts did not have any effect on the way regulators looked at the issue.”
Bruce Kelly, Kathie O’Donnell, Charles Paikert, Lisa Shidler, Aaron Siegel and Brooke Southall contributed to this story.

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