Two consumer groups support expanding principal-trade rule

In an unusual twist, two groups known as advocates for investors have come out in favor of expanding the controversial principal-trade rule to include discretionary accounts and advisory firms affiliated with brokers.

In an unusual twist, two groups known as advocates for investors have come out in favor of expanding the controversial principal-trade rule to include discretionary accounts and advisory firms affiliated with brokers.

Fund Democracy Inc. and the Consumer Federation of America say they are in favor of further liberalization of the new rule that allows brokers to make trades from their own inventories in advisory ac-counts — provided that the Securities and Exchange Commission requires that brokers have procedures in place to make sure any trades being made are fair to investors.

“If you create a principal-trading rule that includes real protections to prevent abusive conduct — and that’s a very big if — then and only then can you consider applying it more broadly,” said Barbara Roper, Pueblo, Colo.-based director of investor protection for the CFA, which is based in Washington.

Organizations that represent financial planners and investment advisers maintain that allowing principal trades in advisory accounts, which have been restricted since passage of the Investment Advisers Act of 1940, would weaken consumer protections by allowing brokers and advisers to unload unwanted securities and by raising the prospect that they would sell securities to clients at inflated prices.

“We think it’s playing with fire,” Duane Thompson, managing director of the Financial Planning Association’s Washington office, said of the notion of expanding the rule. “The SEC has to approach this issue with extreme caution.”

The Denver-based FPA believes the new rule should be restricted to principal trades involving accredited investors, which generally means individuals with a net worth of $1 million or more.

Oxford, Miss.-based Fund Democracy and the CFA sided with the FPA in its successful battle to end fee-based brokerage accounts.

OPPOSING EXPANSION

The National Association of Personal Financial Advisors of Arlington Heights, Ill., and the Investment Adviser Association Inc. of Washington also oppose expanding the rule.

“We think that abuses will occur in this area which will be uncovered as time goes on, and any expansion would be contrary to the best interests of consumers,” said Ron Rhoades, a member of NAFPA’s industry issues committee who is also director of research at Joseph Capital Management LLC in Hernando, Fla.

The position taken by Fund Democracy and the CFA bolsters the prospects that the temporary rule, which was adopted by the SEC in September and is set to expire in 2010, will eventually be made permanent.

“We do agree if they have the right protections in place, a number of provisions they required probably aren’t necessary,” said Mercer Bullard, founder and president of Fund Democracy and assistant professor of law at the University of Mississippi School of Law in Oxford. “This is a deregulatory set of proposals we made.”

Under the temporary rule, dually registered broker-dealer/investment advisers can make principal trades in non-discretionary accounts, as long as oral consent is obtained from clients before the transactions are executed.

In a mid-October speech in New York, Andrew “Buddy” Donahue, director of the SEC’s division of investment management, suggested that the agency would be willing to consider expanding the rule to include discretionary accounts at advisory firms that are affiliated with brokers (InvestmentNews, Nov. 12).

Since oral consent must be obtained from clients before transactions are executed, “the risks are the same whether it’s a discretionary or non-discretionary account,” said Mr. Bullard. “There isn’t a real distinction there.”