In a formal comment letter to the Securities and Exchange Commission (SEC) and a follow-up letter to Chairman William Donaldson, the Consumer Federation of America is calling on the SEC to drop its anti-investor proposal expanding the broker-dealer exclusion in the Investment Advisers Act and instead restore a real functional distinction between brokerage services and advisory services.
The comment letter discusses CFA’s concerns about the approach the Commission has taken in reopening the comment period. The follow-up letter refutes the arguments put forward by the Securities Industry Association in support of the proposed rule. Both CFA documents outline an alternate approach that would create a real functional distinction between brokerage services and advisory services while clarifying that fee-based compensation alone does not automatically trigger Investment Advisers Act regulation.
The broker/investment adviser distinction is important for investors, because investment advisers are subject to a higher standard of conduct than brokers, said CFA Director of Investor Protection Barbara Roper. Among the most important distinctions, investment advisers are fiduciaries with an obligation to place their clients’ interests ahead of their own and to disclose any and all conflicts of interest. “Despite their fancy titles, brokers are salespeople,” Roper said. “They do not have the same fiduciary duty to their customers that advisers have. Instead they are subject to a less exacting obligation to make suitable recommendations. And, while they have some limited obligation to disclose conflicts of interest, those requirements are neither as extensive nor as timely as the disclosure requirements that investment advisers must comply with.”
“Investors lose important protections when they are deprived of the regulatory standards in the Advisers Act,” Roper added. “Those protections are all the more important when advice is offered in combination with product sales, as it is by brokers, since such a combination increases both the potential conflicts of interest and the capacity to inflict harm on the client.”
The Investment Advisers Act excludes broker-dealers, but only if they limit themselves to giving advice that is “solely incidental” to their primary business of buying and selling securities on behalf of clients and don’t receive “special compensation” for that advice. The rule proposal – which reiterates but does not define the solely incidental language – would create an exemption from the special compensation test for non-discretionary fee-based accounts.
The SEC has said the rule is designed to make the nature of services provided by brokers, and not how they are compensated for those services, the primary factor that determines whether the accounts are regulated simply as sales accounts or are also subject to the standards in the Investment Advisers Act. “That is an admirable goal, but it is a goal that the current rule proposal does nothing to achieve,” Roper said.
“The fact that method of compensation has come to be used as the primary factor determining application of the Advisers Act has nothing to do with any shortcomings in the law and everything to do with major shortcomings in the SEC’s enforcement of the law,” Roper said. “Over the better part of two decades, the Commission has allowed brokers to adopt titles for their sales reps, such as financial consultant or financial adviser, designed to portray them as advisers; it has allowed them to offer services, such as financial planning, that are clearly advisory in nature; and it has allowed them to market their services based on the advice offered – all without forcing them to comply with the standards of conduct that govern investment advice. It is that passive regulatory approach, and not changes in compensation methods, that is primarily responsible for erasing the lines between brokers and advisers.”
To ensure that recipients of advisory services receive the protections to which they are entitled, regardless of the nature of the firm offering those services, CFA urged the Commission:
- to define what it means for a broker to offer investment advice that is “solely incidental” to the broker’s primary business of effecting transactions in securities on behalf of clients, and to do so in a way that is consistent with Congress’s clear intent to provide only a very narrow exclusion for the type of “buy this/sell that” recommendations that are an integral part of the broker’s sales function;
- to analyze services currently being offered by brokers to determine which are appropriately regulated as advisory services and which are adequately regulated under a sales standard of conduct;
- to prohibit brokers from advertising or promoting any services other than those defined and regulated as advisory services by the Commission based on the advice offered; and
- to clarify that, when determining whether a broker has received “special compensation” for advice, the standard for fee and commission compensation is the same and depends on whether a portion of that fee or commission consists specifically of compensation for advice.
“Only if it adopts such an approach will the Commission achieve its stated goal of making nature of services provided, rather than method of compensation, the key factor determining application of the Advisers Act,” Roper said.