Brokers who provide investment advice would no longer be exempt from registering as investment advisers under draft legislation unveiled today by Senate Banking Committee Chairman Christopher Dodd, D-Conn.
Brokers who provide investment advice would no longer be exempt from registering as investment advisers under draft legislation unveiled today by Senate Banking Committee Chairman Christopher Dodd, D-Conn.
The 1,136-page discussion draft of financial reform legislation circulated by Mr. Dodd would eliminate the so-called “broker-dealer exemption” from the Investment Advisers Act of 1940. The exemption spares brokers from registering as advisers if the advice they provide to clients is “solely incidental” to selling products.
Under the draft, the Securities and Exchange Commission would be given rulemaking authority to allow brokers who provide advice to conduct principal trades that otherwise would be restricted under the Investment Advisers Act. Investors would have to be protected against conflicts of interest, and the SEC would have to determine allowing brokers to conduct such “prohibited transactions” is in the public interest.
The so-called “broker-dealer exemption” in the Investment Advisers Act of 1940 has long been contentious for investment advisers. In 2007, the Financial Planning Association won a major lawsuit against the SEC based on the provision. The U.S. Court of Appeals for the District of Columbia Circuit ruled that the SEC had incorrectly applied the exemption by allowing brokers who collect asset-based fees to escape from registering as advisers.
Adviser and consumer groups welcomed the Dodd approach to harmonizing adviser regulations.
“It would be a dramatic change,” said Mercer Bullard, president and founder of Fund Democracy Inc., a mutual fund shareholder advocacy group. “Virtually every broker-dealer would have to register as an investment adviser.”
Mr. Bullard said that eliminating the broker-dealer exemption would allow the SEC to increase scrutiny of firms that have escaped adviser registration. One such firm, such as Bernard L. Madoff Investment Securities LLC, perpetrated a massive Ponzi scheme over two decades.
“We think this is a sound approach,” said Neil Simon, vice president for government relations of the Investment Advisers Association, which represents federally registered advisory firms. “This would be a way to give brokers relief from provisions of the Advisers Act” that interfere with the business model of brokerage firms, Mr. Simon said.
Conducting principal transactions, in which brokers sell products to clients from their firm's inventory, is a major part of the brokerage business. Restrictions on principal transactions in the Investment Advisers Act have been a major stumbling block for brokers who want to provide investment advice to clients.
Like the proposed Investor Protection Act approved Oct. 28 by the House Financial Services Committee, the Dodd bill would require any financial service professional providing personal advice to act as a fiduciary.
However, the Dodd bill takes a different approach from the House bill. The House bill would require the SEC to write regulations defining the fiduciary standard for advisers. The Senate bill extends the fiduciary duty to broker-dealers by eliminating the broker-dealer exclusion, and otherwise leaves the Investment Advisers Act unchanged.
“It's the best and simplest approach,” said Dan Barry, director of government relations for the Financial Planning Association. “It makes it clear that the standard that applies to advisers and brokers is the same exact standard, the same exact remedies,” he said.
But the Securities Industry and Financial Markets Association continued to call for rewriting the fiduciary standard to harmonize standards for brokers and advisers. SIFMA supports “the creation of a new, federal fiduciary standard for broker-dealers and investment advisers when they provide personalized investment advice,” Kenneth Bentsen, executive vice president, public policy and advocacy, said in a release.
Adviser groups oppose creating a new fiduciary standard, which they fear would be weakened.
Unlike the House bill, Dodd's draft would allow the SEC to keep fees it collects to fund its operations. SEC Chairman Mary Schapiro has called for such a self-funding mechanism.
That would allow the agency to bypass the congressional appropriations process and it would increase the agency's funding considerably. The agency expects to collect $1.5 billion in fees for the fiscal year that began Oct. 1, SEC spokesman John Nester wrote in an e-mail. The Obama administration has proposed an SEC budget of just over $1 billion for the same fiscal year.
Under the proposed legislation, an Office of the Investor Advocate would also be created within the Securities and Exchange Commission.
The Office of the Investor Advocate would report directly to Congress annually on the 20 most serious problems encountered by investors in dealing with the SEC and the Financial Industry Regulatory Authority Inc., the length of time that each item has remained on the list, actions taken by the SEC or SROs to resolve the problems, and/or why actions have not been taken.
The head of the office would be the Investor Advocate. The Investor Advocate would be appointed by and report to the commission, but the officer would have the power to employ independent counsel, research and service staff that the officer would deem necessary to carry out the functions of the office.
“It creates a position with an enormous amount of clout,” said Mr. Bullard.
The Investor Advocate’s Office “would wield a very large club within the commission,” he said.
No such provision is contained in the Investor Protection Act approved Oct. 28 by the House Financial Services Committee.
