Certain Broker-Dealers Deemed Not To Be Investment Advisers

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SECURITIES AND EXCHANGE COMMISSION 17 CFR Part 275 [Release Nos. 34-50980; IA-2340; File No. S7-25-99] RIN 3235-AH78 Certain Broker-Dealers Deemed Not To Be Investment Advisers AGENCY:

Securities and Exchange Commission.

ACTION:

Proposed rule.

SUMMARY:

The Securities and Exchange Commission is reproposing a rule addressing the application of the Investment Advisers Act of 1940 to broker-dealers offering certain types of brokerage programs. Under the reproposed rule, a broker-dealer providing nondiscretionary advice that is solely incidental to its brokerage services is excepted from the Investment Advisers Act regardless of whether it charges an asset-based or fixed fee (rather than commissions, mark-ups, or mark-downs) for its services. The rule would also state that exercising investment discretion is not solely incidental to brokerage business, and thus, a broker-dealer providing discretionary advice would be deemed to be an investment adviser under the Investment Advisers Act. In addition, under the rule, broker-dealers would not be subject to the Investment Advisers Act solely because they offer full-service brokerage and discount brokerage services, including electronic brokerage, for reduced commission rates. Finally, the Commission is proposing to issue a statement of interpretive position that would clarify when certain broker-dealer advisory services, including financial planning, are solely incidental to brokerage business.

DATES:

Comments should be received on or before February 7, 2005.

ADDRESSES:

Comments may be submitted by any of the following methods:

Electronic Comments

• Use the Commission's Internet comment form ( http://www.sec.gov/rules/proposed.shtml ); or

• Send an e-mail to rule-comments@sec.gov. Please include File Number S7-25-99 on the subject line; or

• Use the Federal eRulemaking Portal ( http://www.regulations.gov ). Follow the instructions for submitting comments.

Paper Comments

• Send paper comments in triplicate to Jonathan G

ic Comments

• Use the Commission's Internet comment form ( http://www.sec.gov/rules/proposed.shtml ); or

• Send an e-mail to rule-comments@sec.gov. Please include File Number S7-25-99 on the subject line; or

• Use the Federal eRulemaking Portal ( http://www.regulations.gov ). Follow the instructions for submitting comments.

Paper Comments

• Send paper comments in triplicate to Jonathan G. Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549-0609.

All submissions should refer to File Number S7-25-99. This file number should be included on the subject line if e-mail is used. To help us process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission's Internet Web site ( http://www.sec.gov/rules/proposed.shtml ). Comments are also available for public inspection and copying in the Commission's Public Reference Room, 450 Fifth Street, NW., Washington, DC 20549. All comments received will be posted without change; we do not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly.

FOR FURTHER INFORMATION CONTACT:

Robert L. Tuleya, Senior Counsel, or Nancy M. Morris, Attorney-Fellow, at 202-942-0719, or Iarules@sec.gov, Office of Investment Adviser Regulation, Division of Investment Management, Securities and Exchange Commission, 450 Fifth St., NW., Washington, D.C. 20549-0506.

SUPPLEMENTARY INFORMATION:

The Securities and Exchange Commission (“Commission” or “SEC”) is proposing rule 202(a)(11)-1 under the Investment Advisers Act of 1940 (“Advisers Act” or “Act”). 1 We are also requesting comment on interpretive positions under section 202(a)(11)(C) of the Act.

1 15 U.S.C. 80b. Unless otherwise noted, when we refer to the Advisers Act, or any paragraph of the Act, we are referring to 15 U.S.C. 80b of the United States Code in which the Act is published.

Table of Contents

I. Background II

r the Investment Advisers Act of 1940 (“Advisers Act” or “Act”). 1 We are also requesting comment on interpretive positions under section 202(a)(11)(C) of the Act.

1 15 U.S.C. 80b. Unless otherwise noted, when we refer to the Advisers Act, or any paragraph of the Act, we are referring to 15 U.S.C. 80b of the United States Code in which the Act is published.

Table of Contents

I. Background II. Discussion of Reproposal A. Fee-Based Brokerage Programs B. Exception for Fee-Based Brokerage Accounts C. Discretionary Asset Management D. Discount Brokerage Programs E. Scope of Exception III. Proposed Statement of Interpretive Position A. Holding Out As an Investment Adviser B. Financial Planning Services C. Wrap Fee Sponsorship D. Other Interpretive Questions IV. General Request for Comment V. Cost Benefit Analysis VI. Effects on Competition, Efficiency and Capital Formation VII. Paperwork Reduction Act VIII. Initial Regulatory Flexibility Analysis IX. Statutory Authority Text Of Rule I. Background

The Advisers Act regulates the activities of certain “investment advisers,” which are defined in section 202(a)(11) as persons who receive compensation for providing advice about securities as part of a regular business. 2 Section 202(a)(11)(C) of the Advisers Act excepts, from the definition, a broker or dealer “whose performance of [advisory] services is solely incidental to the conduct of his business as a broker or dealer and who receives no special compensation therefor.” The broker-dealer exception “amounts to a recognition that brokers and dealers commonly give a certain amount of advice to their customers in the course of their regular business and that it would be inappropriate to bring them within the scope of the [Advisers Act] merely because of this aspect of their business.” 3

of their regular business and that it would be inappropriate to bring them within the scope of the [Advisers Act] merely because of this aspect of their business.” 3

2 For a discussion of the scope of the Advisers Act, see Applicability of the Investment Advisers Act to Financial Planners, Pension Consultants, and Other Persons Who Provide Investment Advisory Services as a Component of Other Financial Services, Ivnestment Advisers Act Release No. 1092 (Oct. 8, 1987) [52 FR 38400 (Oct. 16, 1987)] (“Advisers Act Release No. 1092”).

3 See Opinion of the General Counsel relating to Section 202(a)(11)(C) of the Ivnestment Advisers Act of 1940, Investment Advisers Act Release No. 2 (Oct. 28, 1940) [11 FR 10996 (Sept. 27, 1946)] (“Advisers Act Release No. 2”).

Many securities firms currently are registered with us under both the Securities Exchange Act of 1934 4 (as broker-dealers) and the Advisers Act (as advisers), but treat only certain of their accounts as subject to the Advisers Act. We have viewed the Advisers Act, and the protections afforded by the Act, as applying only to those accounts to which the broker-dealer provides investment advice that is not solely incidental to brokerage services or from which the firm receives special compensation (or both). 5

4 15 U.S.C. 78a (“Exchange Act”).

5 Final Extension of Temporary Rules, Investment Advisers Act Release No. 626 (Apr. 27, 1978) [43 FR 19224 (May 4, 1978)] (“Advisers Act Release No. 626”) (“A broker or dealer who is registered as an investment adviser is not by reason of that fact an ivnestment adviser to those of his brokerage clients to whom he provides advisory services on a solely incidental basis and without special compensation.”)

Extension of Temporary Rules, Investment Advisers Act Release No. 626 (Apr. 27, 1978) [43 FR 19224 (May 4, 1978)] (“Advisers Act Release No. 626”) (“A broker or dealer who is registered as an investment adviser is not by reason of that fact an ivnestment adviser to those of his brokerage clients to whom he provides advisory services on a solely incidental basis and without special compensation.”).

On November 4, 1999, the Commission issued a release proposing for comment a new rule under the Advisers Act in response to the introduction of two new types of brokerage programs offered by full-service broker-dealers “fee-based brokerage programs” and “discount brokerage programs.” 6 The rulemaking addressed whether, as a result of introducing these programs, broker-

6 In the Proposing Release, we referred to what we not term “discount brokerage” programs as “execution-only” programs. Proposing Release, supra note 5. “Discount brokerage” more fully describes the programs referenced in this Release.

Fee-based brokerage programs provide customers a package of brokerage services “ including execution, investment advice, custodial and recordkeeping services “ for a fee based on the amount of assets on account with the broker-dealer ( i.e., an asset-based fee) or a fixed fee. Asset-based fees generally range from 1.10 percent to 1.50 percent of assets. 7 A broker-dealer receiving fee-based compensation may be unable to rely on the broker-dealer exception because the fee constitutes “special compensation” under the Act—that is, it involves the receipt by a broker-dealer of compensation other than brokerage commissions or dealer compensation ( i.e., mark-up, mark-down, or similar fee). 8

7 The Cerulli Edge, Managemed Accounts Edition (1st Quarter 2004) at 2 (“Cerulli Edge 1st Quarter”.)

8 See S. Rep. No. 76-1775, 76th Cong., 3d Sess. 22 (1940) (“S. Rep. No

fee constitutes “special compensation” under the Act—that is, it involves the receipt by a broker-dealer of compensation other than brokerage commissions or dealer compensation ( i.e., mark-up, mark-down, or similar fee). 8

7 The Cerulli Edge, Managemed Accounts Edition (1st Quarter 2004) at 2 (“Cerulli Edge 1st Quarter”.)

8 See S. Rep. No. 76-1775, 76th Cong., 3d Sess. 22 (1940) (“S. Rep. No. 76-1775”) (section 202(a)(11)(C) of the Advisers Act applies to broker-dealers “insofar as their advice is merely incidental to brokerage transactions for which they recieve only brokerage commission.”) (emphasis added). See also Disclosure by Investment Advisers Regarding Wrap Fee Programs, Investment Advisers Act Release No. 1401 (Jan. 13, 1994) at n.2. Our references in this release to “commission-based brokerage” include transactions effected on a prinipal basis for which the broker-delaer is compensated by a mark-up or mark-down.

Discount brokerage programs, including electronic trading programs, give customers who do not want or need advice from brokerage firms the ability to trade securities at a lower commission rate. Electronic trading programs provide customers the ability to trade on-line, typically without the assistance of a registered representative, from any personal computer connected to the Internet. Customers trading electronically may devise their own investment or trading strategies, or may seek advice separately from investment advisers. The introduction of electronic trading and other discount services at a lower commission rate may trigger application of the Advisers Act to any full-service accounts for which the broker-dealer provides some investment advice. This is because the difference in the commission rates represents a clearly definable portion of the brokerage commission that may be primarily attributable to investment advice. Our staff has viewed such a two-tiered fee structure as involving “special compensation” under the Advisers Act. 9

9 Advisers Act Release No

-service accounts for which the broker-dealer provides some investment advice. This is because the difference in the commission rates represents a clearly definable portion of the brokerage commission that may be primarily attributable to investment advice. Our staff has viewed such a two-tiered fee structure as involving “special compensation” under the Advisers Act. 9

9 Advisers Act Release No. 626, supra note 5; Advisers Act Release No. 2, supra note 3; Robert S. Strevell, SEC Staff No-Action Letter (Apr. 29, 1985) (“Strevell No-Action Letter”) (“If two general fee schedules are in effect, either formally or informally, the lower without investment advice and the higher with investment advice, and the difference is primarily attributable to this factor there is special compensation.”).

After reviewing these new programs, we concluded that they were not fundamentally different from traditional brokerage programs. As a general matter, fee-based brokerage programs offer the same general package of services as commission-based brokerage programs. Electronic and other discount brokerage programs, for their part, do not offer any advisory service, but merely make visible that which has always been understood: A portion of the commissions charged by full-service broker-dealers compensate the broker-dealers for advisory services. Thus, we viewed broker-dealers offering these new programs as having re-priced traditional brokerage programs rather than as having created advisory programs. 10

10 For a discussion of “traditional brokerage services” and “traditional brokerage programs” see infra note 42 and accompanying text.

created advisory programs. 10

10 For a discussion of “traditional brokerage services” and “traditional brokerage programs” see infra note 42 and accompanying text.

We were concerned that application of the Advisers Act to broker-dealers offering these new programs would inhibit the development of these programs, which we viewed as potentially providing important benefits to brokerage customers. Most importantly, we believed Congress could not have intended to subject full-service broker-dealers offering these programs to the Advisers Act when, in conducting these programs, broker-dealers offer advice as part of traditional brokerage services.

Under the 1999 proposed rule, a broker-dealer providing investment advice to customers would be excluded from the definition of investment adviser regardless of the form that its compensation takes as long as: (i) The advice is provided on a nondiscretionary basis; (ii) the advice is solely incidental to the brokerage services; and (iii) the broker-dealer prominently discloses to its customers that their accounts are brokerage accounts. These provisions of the proposed rule were designed to make application of the Advisers Act turn more on the nature of the services provided by the broker than on the form of the broker's compensation.

In addition, we proposed that a broker or dealer would not be deemed to have received special compensation solely because the broker or dealer charges a commission, mark-up, mark-down, or similar fee for brokerage services that is greater than or less than one it charges another customer. This provision was designed to permit full-service broker-dealers to offer discounted brokerage, including electronic trading, without having to treat full-price, full-service brokerage customers as advisory clients. 11

to permit full-service broker-dealers to offer discounted brokerage, including electronic trading, without having to treat full-price, full-service brokerage customers as advisory clients. 11

11 We also proposed an amendment to the instructions for Advisers Act Form ADV [17 CFR part 279] regarding calculation of assets under management for investment advisers dually registered as broker-dealers. Proposing Release, supra note 5, at II.B. This proposal was effectively incorporated into the instructions of the new Form ADV adopted by the Commission in September 2000, and is, therefore, not further addressed in this release. See Electronic Filing by Investment Advisers;Amendments to Form ADV, Investment Advisers Act Release No. 1897 (Sept. 12, 2000) [65 FR 57438 (Sept. 22, 2000)].

These new brokerage programs responded to changes in the market place for retail brokerage. 12 They also responded to concerns we have long held about the incentives that commission-based compensation provides to churn accounts, recommend unsuitable securities, and engage in aggressive marketing of brokerage services. These concerns led to the formation, in 1994, of a broad-based committee (“Tully Committee”) whose mandate was to identify conflicts of interest in brokerage industry compensation practices and “best” practices in compensating registered representatives. 13 The Tully Committee found that fee-based compensation would better align the interests of broker-dealers and their clients and would allow registered representatives to focus on their most important role—providing investment advice to individual clients, not generating transaction revenues. 14

12 See Patrick McGeehan, The Media Business: Advertising, Schwab Takes Another Kind of Swipe at the Big Wall Street Firms in a New Campaign, N.Y. TIMES, Aug. 28, 2000, at C11; Jack White and Doug Ramsey, A Belle Epoque for Wall Street, BARRON'S, Oct. 18, 1999, at 54; John Steele Gordon, Manager's Journal: Merrill Lynch Once Led Wall Street. Now It's Catching Up, WALL ST

transaction revenues. 14

13 Report of the Committee on Compensation Practices (Apr. 10, 1995) (“Tully Report”). The committee was formed in 1994 at the suggestion of Commission Chairman Arthur Levitt.

14 Id.

Over the years, many of our enforcement cases and many investor losses can be traced to individual representatives responding to the need to generate commissions rather than service customers. 15 These new fee- 16

15 See, e.g., In the Matter of the Application of Michael T. Studer, Securities Exchange Act Release No. 50543 (Oct. 14, 2004) (churning customer account); In the Matter of Robert H. Wolfson, Securities Exchange Act Release No. 41831 (Sept. In the Matter of J.B. Hanauer & Co., Securities Exchange Act Release No. 41832 (Sept. 2, 1999) (consent) (churning customer accounts and making unsuitable recommendations); In the Matter of John M. Reynolds, Securities Exchange Act Release No. 30036 (Dec. 4, 1991) (engaging in excessive trading and purchasing unsuitable securities); In the Matter of Victor G. Matl, Securities Exchange Act Release No. 22395 (Sept. 10, 1985) (consent) (churning customer accounts and making unsuitable recommendations). Individual investors may also bring private claims. See, e.g., Saxe v. E.F. Hutton & Company, Inc., 789 F.2d 105 (2d Cir. 1986).

16 Proposing Release, supra note 5

ging in excessive trading and purchasing unsuitable securities); In the Matter of Victor G. Matl, Securities Exchange Act Release No. 22395 (Sept. 10, 1985) (consent) (churning customer accounts and making unsuitable recommendations). Individual investors may also bring private claims. See, e.g., Saxe v. E.F. Hutton & Company, Inc., 789 F.2d 105 (2d Cir. 1986).

16 Proposing Release, supra note 5. In a companion release we are today adopting a temporary rule under which a broker-dealer providing non-discretionary advice to customers would be excluded from the definition of investment adviser under the Advisers Act regardless of the form its compensation takes, as long as the advice is solely incidental to the brokerage services. As a result of the adoption of this temporary rule, the staff no-action position announced in the Proposing Release has terminated.

Twenty-five letters were submitted during the comment period. Following the close of the comment period, however, we received hundreds more letters, most of which opposed the rule, and many of which appeared to be form letters. Some commenters wrote multiple letters. In view of ongoing and significant public interest in the proposal, and in order to provide all persons who were interested in this matter a current opportunity to comment, we reopened the period for public comment on the proposed rule in August 2004. 17 In all, we have received over 1,700 comment letters on the proposal. 18

17 Investment Advisers Act Release No. 2278 (Aug. 18, 2004) [69 FR 51620 (Aug. 20, 2004)]. The reopened comment period closed on September 22, 2004. In our release reopening the comment period, we also noted that The Financial Planning Association had filed a petition for judicial review of the proposal. Financial Planning Ass'n v. SEC, No. 04-1242 (D.C. Cir.) (case docketed on July 20, 2004).

18 These comment letters are generally available for viewing and downloading on the Internet at http://www.sec.gov/rules/proposed/s72599.shtml

, 2004. In our release reopening the comment period, we also noted that The Financial Planning Association had filed a petition for judicial review of the proposal. Financial Planning Ass'n v. SEC, No. 04-1242 (D.C. Cir.) (case docketed on July 20, 2004).

18 These comment letters are generally available for viewing and downloading on the Internet at http://www.sec.gov/rules/proposed/s72599.shtml. Letters are otherwise available for inspection and copying in the Commission's Public Reference Room, 450 Fifth Street, NW., Washington, DC 20549 (File No. S7-25-99).

Most commenters discussed only the provisions of the rule that addressed fee-based brokerage programs. Broker-dealers commenting on the rule strongly supported it. 19 They asserted that fee-based brokerage programs benefited customers by aligning the interests of representatives with those of their customers. 20 According to some of these broker-dealers, the application of the Advisers Act would discourage the introduction of fee-based programs by imposing what these brokerage firms viewed to be a duplicative and unnecessary regulatory regime. 21 Other commenters argued that investors do not lose relevant protections when they deal with a brokerage firm instead of an advisory firm. 22

19 See, e.g., Comment Letter of Merrill, Lynch, Pierce, Fenner & Smith Incorporated (Sept. 22, 2004) (“Merrill Lynch Sept. 22, 2004 Letter”); Comment Letter of Raymond James Financial, Inc. (Sept. 21, 2004); Comment Letter of Northwestern Mutual Investment Services, LLC (Sept. 22, 2004); Comment Letter of Smith Barney Citigroup (Jan. 14, 2000) (“Smith Barney Letter”). See also Comment letter of Securities Industry Association (Sept. 22, 2004) (“SIA Sept. 22, 2004 Letter”) (representing broker-dealers).

20 Comment Letter of Citigroup Global Markets Inc. (Sept. 22, 2004) (“CGMI Letter”); Comment Letter of Charles Schwab & Co. (Sept. 22, 2004) (“Charles Schwab Sept. 22, 2004 Letter”); Comment Letter of Securities Industry Association (Sept. 13, 2000); (“SIA Sept

See also Comment letter of Securities Industry Association (Sept. 22, 2004) (“SIA Sept. 22, 2004 Letter”) (representing broker-dealers).

21 CGMI Letter, supra note 20, Merrill Lynch Sept. 22, 2004 Letter, supra note 19; Comment Letter of Securities Industry Association (Jan. 13, 2000).

22 E.g., Comment Letter of Hardy Callcott (Aug. 23, 2004); SIA Sept. 22, 2004 Letter, supra note 19.

A large number of investment advisers—in particular, financial planners—and a few consumer groups submitted letters strongly opposed to the proposed rule. 23 Some of these commenters took issue with our conclusions that the new programs do not differ fundamentally from traditional brokerage programs. 24 These and other commenters argued that the broker-dealers that would be affected by the rule are providing advisory services similar to, or the same as, those that investment advisers provide and thus should be subject to the Advisers Act. 25 Many of these commenters asserted that the adoption of the rule would deny investors important protections provided by the Act, in particular, the fiduciary duties and disclosure obligations to which advisers are held. 26 Another theme among many opponents of the rule was the perceived competitive implications for financial planners, which would generally be subject to the Act, while broker-dealers would not. 27

ally be subject to the Act, while broker-dealers would not. 27

23 E.g., Comment Letter of Carl Kunhardt (Dec. 28, 1999); Comment Letter of Pamela A. Jones (Jan. 4, 2000) (“Jones Letter”); Comment Letter of Investment Counsel Association of America (Jan. 12, 2000) (“ICAA Jan. 12, 2000 Letter”) (representing SEC-registered investment advisers); Comment Letter of Consumer Federation of America (Jan. 13, 2000) (“CFA Jan. 13, 2000 Letter”); Comment Letter of The Financial Planning Association (Jan. 14, 2000) (“FPA Jan. 14, 2000 Letter”) (representing financial planners); Comment Letter of AARP (Nov. 17, 2003) (“AARP Letter”); Comment Letter of PFPG Fee-Only Advisors (June 21, 2004); Comment Letter of Timothy M. Montague (Sept. 10, 2004); Comment Letter of William S. Hrank (Sept. 20, 2004); Comment Letter of Marilyn C. Dimitroff (Sept. 21, 2004) (“Dimitroff Letter”).

24 E.g., FPA Jan. 14, 2000 Letter, supra note 23.

25 See, e.g., Comment Letter of Arthur V. von der Linden (May 10, 2000); CFA Jan. 13, 2000 Letter, supra note 23; FPA Jan. 14, 2000 Letter, supra note 23; ICAA Jan. 12, 2000 Letter, supra note 23.

26 See, e.g., Comment Letter of American Institute of Certified Public Accountants (Sept. 22, 2004) (“AICPA Sept. 22, 2004 Letter”); CFA Jan. 13, 2000 Letter, supra note 23; FPA Jan. 14, 2000 Letter, supra note 23.

27 See, e.g., Comment Letter of Dan Jamieson (June 1, 2000); Comment Letter of Joel P. Bruckenstein (May 31, 2000); Comment Letter of Margaret Lofaro (May 8, 2000); Comment Letter of Shawnee Barbour (Sept. 13, 2004); Comment Letter of Roselyn Wilkinson (Sept. 13, 2004); Comment Letter of Robert J. Lindner (Sept. 14, 2004); Comment Letter of Robert Lawson (Sept. 16, 2004); Comment Letter of Linda Patchett (Sept. 20, 2004) (“Patchett Letter”); Comment Letter of John Ellison (Sept. 20, 2004); Comment Letter of Connie Brezik (Sept. 18, 2004); Comment Letter of Keven M. Doll (Sept. 20, 2004); Comment Letter of Phoebe M. White (Sept. 20, 2004); Comment Letter of Eric G. Shisler (Sept

of Robert J. Lindner (Sept. 14, 2004); Comment Letter of Robert Lawson (Sept. 16, 2004); Comment Letter of Linda Patchett (Sept. 20, 2004) (“Patchett Letter”); Comment Letter of John Ellison (Sept. 20, 2004); Comment Letter of Connie Brezik (Sept. 18, 2004); Comment Letter of Keven M. Doll (Sept. 20, 2004); Comment Letter of Phoebe M. White (Sept. 20, 2004); Comment Letter of Eric G. Shisler (Sept. 20, 2004); Comment Letter of Jami M. Thornton (Sept. 20, 2004); see also Comment Letter of Consumer Federation of America (Feb. 28, 2000) (“CFA Feb. 28, 2000 Letter”).

Some opponents of the rule urged that the form of compensation remained a good indicator of whether an account should be treated as an advisory account. 28 Others, however, agreed with the Proposing Release that compensation was no longer a valid distinction. 29 Many commenters focused on whether and when advisory services can be considered “solely incidental to” brokerage and urged us to provide guidance on the meaning of the “solely incidental to” requirement. 30 In this regard, these and other commenters urged us to focus on how broker-dealers held themselves out to investors. 31 32 In a related vein, many commenters urged us to strengthen the disclosure required of broker-dealers availing themselves of the exception. 33

28 Comment Letter of Investment Counsel Association of America (Sept. 22, 2004) (“ICAA Sept. 22, 2004 Letter”); CFA Feb. 28, 2000 Letter, supra note 27; Comment Letter of Federated Investors, Inc. (Jan. 14, 2000) (“Federated Letter”).

29 See, e.g., Comment Letter of Gilmond & Gilmond Financial Consulting Associates, Ltd. (Dec. 31, 1999).

30 AICPA Sept. 22, 2004 Letter, supra note 26; Comment Letter of The Financial Planning Association (June 21, 2004) (“FPA June 21, 2004 Letter”); Comment Letter of Consumer Federation of America (Nov. 4, 2004); ICAA Jan. 12, 2000 Letter, supra note 23.

31 Comment Letter of National Association of Personal Financial Advisors (Sept

& Gilmond Financial Consulting Associates, Ltd. (Dec. 31, 1999).

31 Comment Letter of National Association of Personal Financial Advisors (Sept. 21, 2004) (NAPFA Letter”); Comment Letter of Charles O'Connor (Sept. 14, 2004); Comment Letter of Abbas A. Heydri (Sept. 16, 2004) (“Heydri Letter”); Patchett Letter, supra note 27; Comment Letter of Henry L. Woodward (Sept. 21, 2004); Dimitroff Letter, supra note 23; Comment Letter of North American Securities Administrators Association, Inc. (Oct. 6, 2004) (“NASAA Letter”); AICPA Sept. 22, 2004 Letter, supra note 26; ICAA Sept. 22, 2004 supra note 28; CFA Jan. 13, 2000 Letter, supra note 23; Jones Letter, supra note 23.

32 E.g., AARP Letter, supra note 23.

33 E.g., Comment Letter of the CFP Board (Jan. 13, 2000); FPA Jan. 14, 2004 Letter, supra note 23; FPA Letter June 21, 2004, supra note 30; ICAA Jan. 12, 2000 Letter, supra note 23. See also NAPFA Letter, supra note 31. Some commenters also took issue with the policy judgment underlying the rule, arguing that it departs from the design of the securities laws to protect investors. FPA Jan. 14, 2000 Letter, supra note 23; Comment Letter of the Financial Planning Association (June 24, 2004); Comment Letter of T. Rowe Price Associates, Inc. (Jan. 14, 2000) (“T. Rowe Price Jan. 14, 2000 Letter”). Other commenters challenged our authority to adopt the rule, arguing that it is inconsistent with the Congressional intent embodied in section 202(a)(11) of the Advisers Act. Comment Letter of The Financial Planning Association (Dec. 7, 2001) (“FPA Dec. 7, 2001 Letter”); CFA Jan. 13, 2000 Letter, supra note 23; Comment Letter of Joseph Capital Management, LLC (Aug. 30, 2004).

, 2000 Letter”). Other commenters challenged our authority to adopt the rule, arguing that it is inconsistent with the Congressional intent embodied in section 202(a)(11) of the Advisers Act. Comment Letter of The Financial Planning Association (Dec. 7, 2001) (“FPA Dec. 7, 2001 Letter”); CFA Jan. 13, 2000 Letter, supra note 23; Comment Letter of Joseph Capital Management, LLC (Aug. 30, 2004).

II. Discussion of Reproposal

The many comments we received have caused us to re-consider our proposed rule. We share commenters' concern that investors are confused about the differences between brokerage and advisory accounts and, as discussed below, we are proposing stronger disclosure. We are requesting comment on whether broker-dealers have contributed to this confusion when they refer to their representatives as “financial advisors,” “financial consultants” or similar titles, and we are requesting comment on this issue. We agree with the many commenters who urged us to develop better and clearer guidance on when a broker's advisory activities are “solely incidental to” its brokerage business, and are seeking additional comment on guidance we might provide.

We continue, however, to believe that fee-based brokerage has the potential to provide significant benefits to brokerage customers. Our reproposal therefore reflects our belief that when broker-dealers offer advisory services as part of the traditional package of brokerage services, broker-dealers ought not to be subject to the Advisers Act merely because they re-price those services. The reproposal also reflects our belief that broker-dealers should be permitted to offer both full-service brokerage and discount brokerage services without triggering application of the Advisers Act. The reproposal also reflects our belief that a broker-dealer providing discretionary advice would be deemed to be an investment adviser under the Advisers Act. We look forward to learning commenters' views on these matters.

our belief that broker-dealers should be permitted to offer both full-service brokerage and discount brokerage services without triggering application of the Advisers Act. The reproposal also reflects our belief that a broker-dealer providing discretionary advice would be deemed to be an investment adviser under the Advisers Act. We look forward to learning commenters' views on these matters.

A. Fee-Based Brokerage Programs

Commenters on our original proposal generally fell into two groups—one representing broker-dealers and the other representing investment advisers, including financial planners. These two groups viewed the development of fee-based brokerage accounts through different lenses, and came to entirely different conclusions. Advisers saw the introduction of fee-based brokerage programs as the culmination of a migration from a relationship primarily characterized by customers paying for brokerage transactions to one in which advisory services predominate—a shift they viewed as dramatic. 34 They held up broker-dealers” marketing of these accounts based on the quality of advisory services as evidence that these were, in essence, primarily advisory accounts and urged that we, therefore, treat them as advisory accounts. 35 Broker-dealers viewed the new fee-based programs as providing the same services, including investment advice, they have traditionally provided to customers. 36 While they acknowledged that these programs have generally been marketed based on the advice involved, some of these commenters pointed out that broker-dealers have long sold retail brokerage by promoting ancillary services such as advice. 37 They were concerned that a view of the broker-dealer exception that turned on whether full-service brokerage accounts were marketed to any extent based on the provision of advice would require that we treat all full-service accounts as advisory accounts

olved, some of these commenters pointed out that broker-dealers have long sold retail brokerage by promoting ancillary services such as advice. 37 They were concerned that a view of the broker-dealer exception that turned on whether full-service brokerage accounts were marketed to any extent based on the provision of advice would require that we treat all full-service accounts as advisory accounts. Broker-dealers did not view the change in the pricing of brokerage accounts as significant except insofar as it better aligns the interests of registered representatives with those of their customers. 38 We request further comment on these differing views of the practices of broker-dealers and the implications for our rulemaking. As discussed below, we believe that commenters have raised important issues that concern us and should concern all market participants. We are therefore reproposing the rule. Before we discuss the elements of the reproposed rule, however, we draw attention to five areas that we consider to be important to our decision whether to adopt a final rule.

34 See, e.g., Federated Letter, supra note 28; ICAA Jan. 12, 2000 Letter, supra note 23; CFA Feb. 28, 2000 Letter, supra note 27; FPA Jan. 14, 2000 Letter, supra note 23; Comment Letter of Jared W. Jameson (Sept. 16, 2004); Comment Letter of Geoffrey F. Fosie (Sept. 22, 2004). See also CFA Jan. 13, 2000 Letter, supra note 23; Comment Letter of the Foundation for Fiduciary Studies (Sept. 12, 2004).

35 See, e.g., Comment Letter of Roy T. Diliberto (Aug. 24, 2004); Comment Letter of Don B. Akridge (Sept. 7, 2004); Comment Letter of William K. Dix, Jr. (Sept. 21, 2004) (“Dix Letter”). See also CFA Jan. 13, 2000 Letter, supra note 23.

36 See, e.g., Comment Letter of Paine Webber Incorporated (Jan. 14, 2000) (“Paine Webber Letter”); Comment Letter of U.S. Bancorp Piper Jaffray Inc. (Jan. 19, 2000) (“U.S. Bancorp Letter”); Comment Letter of Prudential Securities Incorporated (Jan. 31, 2000) (“Prudential Letter”); Merrill Lynch Sept

am K. Dix, Jr. (Sept. 21, 2004) (“Dix Letter”). See also CFA Jan. 13, 2000 Letter, supra note 23.

37 See, e.g., U.S. Bancorp Letter, supra note 36; Prudential Letter, supra note 36. One commenter opposed to the rule pointed to specific advertising campaigns as evidence that “over at least the last decade” broker-dealers have, in their view, inappropriately been permitted to market themselves as though their primary service offered was advice. CFA Jan. 13, 2000 Letter, supra note 23.

38 See, e.g., U.S. Bancorp Letter, supra note 36; Prudential Letter, supra note 36; CGMI Letter, supra note 20; Merrill Lynch Sept. 22, 2004 Letter, supra note 19; SIA Sept. 22, 2004 Letter, supra note 19.

1. History of the Broker-Dealer Exception

Broker-dealers have traditionally provided investment advice that is substantial in amount, variety, and importance to their customers. 39 This was well understood in 1940 when Congress passed the Advisers Act. The broker-dealer exception in the Act was designed not to except broker-dealers whose advice to customers is minor or insignificant, but rather to avoid additional and duplicative regulation of broker-dealers, 40 which were regulated under provisions of the Exchange Act that had been enacted six years earlier. 41 The exception also differentiated between advice provided by broker-dealers to customers as part of a package of traditional brokerage services 42 for 43 and advice provided through broker-dealer's special advisory departments for which customers separately contracted and paid a fee “ which was covered by the Act

ated under provisions of the Exchange Act that had been enacted six years earlier. 41 The exception also differentiated between advice provided by broker-dealers to customers as part of a package of traditional brokerage services 42 for 43 and advice provided through broker-dealer's special advisory departments for which customers separately contracted and paid a fee “ which was covered by the Act. 44 Although, as discussed above, the Advisers Act was written in such a way to cover fee-based programs because the fee would constitute “special compensation,” it does not appear to have been Congress” intent to apply the Act to cover broker-dealers providing advice as part of the package of brokerage services they provide under fee-based brokerage programs.

39 Charles F. Hodges, WALL STREET (1930) (“WALL STREET”) at 253-85; Twentieth Century Fund, The SECURITY MARKETS (“SECURITY MARKET”) (1935) 633-43.

40 Research Department of the Illinois Legislative Council, Statutory Regulation of Investment Advisers (prepared by the Research Department of the Illinois Legislative Council) reprinted in Investment Company Act: Hearings Before a Subcomm. of the Senate Committee on Banking and Currency, at 1007 (1940), 76th Cong. 3d Sess.; The Advisers Act: Hearings on H.R. 10065 Before a Subcomm. of the House Comm. on Interstate and Foreign Commerce, 76th Cong., at 88 (1940) (“Hearings on H.R. 10065”).

41 48 Stat. 881, Pub. L. 73-291 (June 6, 1934). Four years later in the Maloney Act, Congress amended the Exchange Act to authorize the Commission to register national securities associations. Pub. L. 75-719, 52 Stat. 1070 (June 25, 1938).

(June 25, 1938).

42 Then, as now, brokerage services included services provided throughout the execution of a securities transaction, including providing research and advice prior to a decision to buy or sell, implementing that decision on the most advantageous terms and executing the transaction, arranging for delivery of securities by the seller and See Exchange Act section 28(e)(3), 15 U.S.C. 78bb(e)(3). See also generally WALL STREET, supra note 39. When we refer to “traditional brokerage programs” we mean those programs that offer traditional brokerage services for commissions. As a general matter, when we refer to “new fee-based programs” we mean those programs that offer traditional brokerage services for fees other than commissions. See supra notes 7—8 and accompanying text.

43 See S. REP. NO. 76-1775, supra note 8, at 22; H.R. REP. NO. 76-2639, at 28, 76th Cong. 3d Sess. (“H.R. REP. NO. 76-2639”). See also Thomas P. Lemke & Gerald T. Lins, REGULATION OF INVESTMENT ADVISERS § 1:19 (“The exception in section 202(a)(11)(C) was included in the Advisers Act because broker-dealers routinely give investment advice as part of their brokerage activities, yet are already subject to extensive regulation under the 1934 Act and possibly state law”); Thomas P. Lemke, Investment Advisers Act Issues for Broker-Dealers, SECURITIES & COMMODITIES REGULATION at 214 (Dec. 9, 1987) (“While most broker-dealers initially will come within the definition of an investment adviser, it is clear that Congress did not intend brokerage activities to be regulated under the 1940 Act [citing S. REP. NO. 76-1775]. Rather, such activities were intended to be regulated under the 1934 Act without the additional and often duplicative requirements under the 1940 Act.”).

44 See Hearings on S. 3580, supra note 40, at 711 (testimony of Douglas T

in the definition of an investment adviser, it is clear that Congress did not intend brokerage activities to be regulated under the 1940 Act [citing S. REP. NO. 76-1775]. Rather, such activities were intended to be regulated under the 1934 Act without the additional and often duplicative requirements under the 1940 Act.”).

44 See Hearings on S. 3580, supra note 40, at 711 (testimony of Douglas T. Johnston, vice-president of Investment Counsel Association of America) (“The definition of 'investment adviser' as given in the bill * * * would include * * * certain investment banking and brokerage houses which maintain investment advisory departments and make charges for services rendered * * *”). The earliest Commission staff interpretations of the Advisers Act also reflect the same understanding, i.e., that the Act was intended to cover broker-dealers only to the extent that they were offering investment advice as a distinct service for which they were specifically compensated. See Advisers Act Release No. 2, supra note 3 (“[T]hat portion of clause (C) which refers to ‘special compensation’ amounts to an equally clear recognition that a broker or dealer who is specially compensated for the rendition of advice should be considered an investment adviser and not be excluded from the purview of the Act merely because he is also engaged in effecting market transactions in securities. It is well known that many brokers and dealers have investment advisory departments which furnish investment advice for compensation in the same manner as does an investment adviser who operates solely in an advisory capacity.”).

tments which furnish investment advice for compensation in the same manner as does an investment adviser who operates solely in an advisory capacity.”).

The Advisers Act was enacted in an era when broker-dealers were paid fixed commission rates for the traditional package of services (including investment advice), and Congress understood “special compensation” to mean non-commission compensation. 45 There is no evidence that the “special compensation” requirement was included in section 202(a)(11)(C) for any purpose beyond providing an easy way of accomplishing the underlying goal of excepting only advice that was provided as part of the package of traditional brokerage services. 46 In particular, neither the legislative history of section 202(a)(11)(C) nor the broader history of the Advisers Act as a whole, considered in light of contemporaneous industry practice, suggests that, in 1940, Congress viewed the form of compensation for the services at issue—commission versus fee-based compensation—as having any independent relevance in terms of the advisory services the Act was intended to reach.

45 At the time the Advisers Act was enacted, Congress understood “special compensation” to mean compensation other than commissions. S. REP. NO. 76-1775, supra note 8, at 22.

46 Of course, the absence of “special compensation” was necessary but not sufficient for the section 202(a)(11)(C) exception. But the other requirement—that the advice be provided “solely incidental to” the conduct of the brokerage business—has always required a judgment based on the facts and circumstances and was not the sort of “bright-line” test that non-commission “special compensation” was

Thus, our reading of the legislative history in the context of brokerage industry practice at the time the Act was passed suggests that in drawing the line to determine when broker-dealers should be subject to the Advisers Act, we should focus our attention on the package of services offered by broker-dealers, including advisory services, rather than on the significance or importance of those advisory services within the context of that package. Because fee-based brokerage programs offer substantially the same package of services offered as part of traditional full service brokerage programs as they were understood in 1940, we believe that it would be appropriate for us to propose a rule allowing brokers to offer these programs without being subject to the Advisers Act.

In the Proposing Release, we expressed concern that, should these fee-based brokerage programs gain wide-spread acceptance, most full-service brokerage arrangements might eventually be subject to regulation under both the Exchange Act and Advisers Act if we were not to except from the Advisers Act broker-dealers offering these programs. The intervening years have substantiated that concern. Today fee-based brokerage accounts are offered by most larger broker-dealers, and hold over $254 billion of customer assets. 47 Industry observers expect that fee-based programs will continue to grow as broker-dealers move away from transaction-based brokerage relationships that provide unsteady sources of revenue. 48

47 The Cerulli Edge, Managed Accounts Edition (3rd Quarter 2004) (“Cerulli Edge 3rd Quarter”).

48 Cerulli Edge 1st Quarter, supra note 7

r broker-dealers, and hold over $254 billion of customer assets. 47 Industry observers expect that fee-based programs will continue to grow as broker-dealers move away from transaction-based brokerage relationships that provide unsteady sources of revenue. 48

47 The Cerulli Edge, Managed Accounts Edition (3rd Quarter 2004) (“Cerulli Edge 3rd Quarter”).

48 Cerulli Edge 1st Quarter, supra note 7.

Would our failure to adopt this reproposed rule eventually result in the extension of the Advisers Act to most brokerage relationships? Would such a result be inconsistent with the intent of the Advisers Act, which was designed to fill a regulatory gap that permitted firms and individuals to engage in advisory activities without being regulated at the same time as it excepted broker-dealers from duplicative regulation? 49 We request comment on our reading of the legislative history of the broker-dealer exception. Do commenters agree that our reproposed rule is necessary to preserve the scope of the Advisers Act as Congress had intended it?

49 See Hearings on S. 3580, supra note 40, at 716-18, 736-753 (Advisers Act filled a regulatory gap in which firms and individuals engaged in advisory activities without being regulated.).

Would application of the Advisers Act to a potentially large number of brokerage accounts interfere with the market-making role of broker-dealers and the efficiency of the capital markets? For example, section 206(3) of the Advisers Act restricts the ability of advisers to engage in principal transactions with clients. How would such a restriction affect broker-dealers' market making and other principal activities? What would be the consequences to the liquidity of the securities markets?

2. Investor Protections

Many commenters opposing the proposed rule focused their arguments on additional investor protections that regulation under the Advisers Act provides and argued that the rule would harm investors

ts. How would such a restriction affect broker-dealers' market making and other principal activities? What would be the consequences to the liquidity of the securities markets?

2. Investor Protections

Many commenters opposing the proposed rule focused their arguments on additional investor protections that regulation under the Advisers Act provides and argued that the rule would harm investors. 50 Most of these comments assumed that clients of advisers received substantially more protections from the federal securities laws than do customers of broker-dealers.

50 See e.g., CFA Jan. 13, 2000 Letter, supra note 23; FPA Jan. 14, 2000 Letter, supra note 23; see also ICAA Jan. 12, 2000 Letter, supra note 23.

To some extent, these comments amount to criticisms of the broker-dealer exception in section 202(a)(11)(C), which permits broker-dealers to provide advice without 51

51 Many of the commenters focused on the conflicts under which brokers function. Congress, however, was well aware of these conflicts. See, e.g., Hearings on S. 3580, supra note 40 at 736 (“Some of these organizations using the descriptive title of investment counsel were in reality dealers or brokers offering to give advice free in anticipation of sales and brokerage commissions on transactions executed upon such free advice”); REPORT ON INVESTMENT COUNSEL, INVESTMENT MANAGEMENT, INVESTMENT SUPERVISORY, AND INVESTMENT ADVISORY SERVICES (1939) (H.R. DOC. NO. 477) 23-25 (quoting testimony of investment advisers regarding “vital conflicts” in broker-dealers providing investment advice when they were at the same time intending to sell particular securities they owned); Statutory Regulation of Investment Advisers, reprinted in Hearings on S

TMENT COUNSEL, INVESTMENT MANAGEMENT, INVESTMENT SUPERVISORY, AND INVESTMENT ADVISORY SERVICES (1939) (H.R. DOC. NO. 477) 23-25 (quoting testimony of investment advisers regarding “vital conflicts” in broker-dealers providing investment advice when they were at the same time intending to sell particular securities they owned); Statutory Regulation of Investment Advisers, reprinted in Hearings on S. 3580, supra note 40 at 1010 (“This might give rise to questions as to whether a counselor who is also a dealer or broker can be relied upon always to give unbiased advice.”); SEC, REPORT ON THE FEASIBILITY AND ADVISABILITY OF THE COMPLETE SEGREGATION OF THE FUNCTIONS OF DEALER AND BROKER, AT XV (June 20, 1936) (submitted to Congress pursuant to section 11(e) of the Securities Exchange Act of 1934) (“A broker who trades for his own account or is financially interested in the distribution or accumulation of securities, may furnish his customers with investment advice inspired less by any consideration of their needs than by the exigencies of his own position.”). Despite such conflicts, Congress nonetheless determined to except brokers providing investment advice from the Advisers Act as set out in section 202(a)(11)(C).

Contrary to the perception of many commenters, broker-dealers are under obligations to disclose conflicts of interest. Those obligations derive from many sources, including agency law, the shingle theory, antifraud provisions of the securities laws and the rules and regulations of the Commission and the SROs.

Moreover, the differences on which many commenters focused may not be as great as they asserted. Broker-dealers are subject to extensive oversight by the Commission and one or more self-regulatory organizations under the Exchange Act. The Exchange Act, Commission rules, and SRO rules provide substantial protections for broker-dealer customers that in many cases are more extensive than those provided by the Advisers Act and the rules thereunder

ers focused may not be as great as they asserted. Broker-dealers are subject to extensive oversight by the Commission and one or more self-regulatory organizations under the Exchange Act. The Exchange Act, Commission rules, and SRO rules provide substantial protections for broker-dealer customers that in many cases are more extensive than those provided by the Advisers Act and the rules thereunder. 52

52 Beginning in 1937, the Commission adopted rules to regulate broker-dealers' activities in the over-the-counter market. See Exchange Act Rule 15c1-1 [17 CFR 240.15c1-1], et seq. These rules, adopted under antifraud authority, complement other antifraud rules governing broker-dealers' activities. See Exchange Act Rule 10b-1 [17 CFR 240.10b-1], et seq. The Commission also has set out detailed requirements for information that broker-dealers must provide their customers at or before the completion of securities transactions. See id. And the Commission has adopted heightened sales practice and disclosure requirements for sales of penny stocks. See Exchange Act Rule 15g9-1 [17 CFR 240.15g9-1], et seq. In addition to the general rules governing the over-the-counter market, which were adopted in 1937, other rules have been adopted to prevent fraud and manipulation, as well as establish qualification standards for broker-dealers. See Exchange Act Rule 15c2-1 [17 CFR 240.15c2-1], et seq. , Rule 10b-5 [17 CFR 240.10b-5], Rules 15b7-1 [17 CFR 240.15b7-1], and Rule 19h-1 [17 CFR 240.19h-1]. The self-regulatory organizations (“SROs”) have also adopted rules increasing their supervision of broker-dealers since 1940. For example, NASD established a clear suitability obligation for broker-dealers that recommend securities to investors, as well as extensive rules governing communications with the public, advertising standards for broker-dealers, and requirements for fair pricing in the over-the-counter market. See NASD Rule 2310, Rule 2210, and Rule 2440

increasing their supervision of broker-dealers since 1940. For example, NASD established a clear suitability obligation for broker-dealers that recommend securities to investors, as well as extensive rules governing communications with the public, advertising standards for broker-dealers, and requirements for fair pricing in the over-the-counter market. See NASD Rule 2310, Rule 2210, and Rule 2440. As broker-dealers' business models continue to evolve, SROs continue to respond by adopting targeted new rules and providing other forms of guidance. Through these efforts, SROs can ensure that the sales practice requirements keep pace with their members' activities and address any resulting investor protection concerns. For example, recently NASD published a Notice to Members concerning fee-based compensation programs, reminding members that they must have reasonable grounds for believing that a fee-based programs, reminding members that they must have reasonable grounds for believing that a fee-based program is appropriate for a particular customer, taking into account the services provided, the cost, and customer preferences. See NASD Notice to Members 03-68 (Nov. 2003). Also, in February 2004, the NYSE filed with the Commission a rule proposal governing non-managed fee-based accounts. See SR-NYSE-2004-13.

The Exchange Act also provides significant investor protections, and, since 1940, the Exchange Act has been amended numerous times to, among other things, subject broker-dealers to increasingly detailed regulatory oversight. For example, in 1964, the Exchange Act was amended to provide for improved qualification and disciplinary procedures for registered broker-dealers and to expand substantially the responsibilities of the NASD under more intensive Commission oversight. Pub. L. No. 88-467, 78 Stat. 580, (Aug. 20, 1964)

times to, among other things, subject broker-dealers to increasingly detailed regulatory oversight. For example, in 1964, the Exchange Act was amended to provide for improved qualification and disciplinary procedures for registered broker-dealers and to expand substantially the responsibilities of the NASD under more intensive Commission oversight. Pub. L. No. 88-467, 78 Stat. 580, (Aug. 20, 1964). Later, the Securities Acts Amendments of 1975, considered the most significant securities legislation since the Exchange Act, end fixed commission rates, initiated action toward development of a national market system, and granted the Commission final authority in the adoption and amendment of SRO rules. Pub. L. No. 94-29, 89 Stat. 97 (June 4, 1975). In addition, the Penny Stock Reform Act of 1990 enhanced regulation of broker-dealers that sell penny stocks to investors. Pub. L. No. 101-429, 104 Stat. 931 (Oct. 15, 1990). More recently, the Gramm-Leach-Bliley Act of 1999 limited the extent to which commerical banks may act as brokers or dealers without broker-dealer registration. Pub. L. No. 106-102, 113 Stat. 1138 (Nov. 1, 1999).

Many commenters asserted that the Commission, by providing the proposed exception, would relieve broker-dealers of the fiduciary responsibility to clients that is imposed by the Advisers Act. 53 In some cases, such as when broker-dealers assume positions of trust and confidence with their customers similar to those of advisers, broker-dealers have been held to similar standards. 54 However, broker-dealers often play roles substantially different from investment advisers and in such roles they should not be held to standards to which advisers are held. For example, an investor who engages a broker-dealer to sell certain stocks should not be heard to complain a week later that the broker-dealer should have advised him to hold on to those stocks in order to take advantage of a tax benefit

oker-dealers often play roles substantially different from investment advisers and in such roles they should not be held to standards to which advisers are held. For example, an investor who engages a broker-dealer to sell certain stocks should not be heard to complain a week later that the broker-dealer should have advised him to hold on to those stocks in order to take advantage of a tax benefit. Thus we believe that broker-dealers and advisers should be held to similar standards depending not upon the statute under which they are registered, but upon the role they are playing.

53 AICPA Sept. 22, 2004 Letter, supra note 26; CFA Jan. 13, 2000 Letter, supra note 23; FPA Jan. 14, 2000 Letter, supra note 23.

54 See, e.g. , Arleen W. Hughes, 27 S.E.C. 629 (1948) (noting that fiduciary requirements generally are not imposed upon broker-dealers who render investment advice as an incident to their brokerage unless they have placed themselves in a position of trust and confidence), aff'd sub nom. Hughes v. SEC, 174 F.2d 969 (D.C. Cir. 1949); Leib v. Merrill Lynch, Pierce, Fenner & Smith, Inc. 461 F. Supp. 951 (E.D. Mich. 1978), aff'd, 647 F. 2d. 165 (6th Cir. 1981) (recognizing that broker who has de facto control over non-discretionary account generally owes customer duties of a fiduciary nature; looking to customer's sophistication, and the degree of trust and confidence in the relationship, among other things, to determine duties owed); Paine Webber, Jackson & Curtis, Inc. v. Adams, 718 P.2d. 508 (Colo. 1986) (evidence “that a customer has placed trust and confidence in the broker” by giving practical control of account can be “indicative of the existence of a fiduciary relationship”); MidAmerica Federal Savings & Loan v. Shearson/American Express, 886 F.2d. 1249 (10th Cir. 1989) (fiduciary relationship existed where broker was in position of strength because it held its agent out as an expert); SEC v. Ridenour, 913 F.2d. 515 (8th Cir

aced trust and confidence in the broker” by giving practical control of account can be “indicative of the existence of a fiduciary relationship”); MidAmerica Federal Savings & Loan v. Shearson/American Express, 886 F.2d. 1249 (10th Cir. 1989) (fiduciary relationship existed where broker was in position of strength because it held its agent out as an expert); SEC v. Ridenour, 913 F.2d. 515 (8th Cir. 1990) (bond dealer owed fiduciary duty to customers with whom he had established a relationship of trust and confidence); C. Weiss, A Review of the Historic Foundations of Broker-Dealer Liability for Breach of Fiduciary Duty, 23 Iowa J. Corp. Law 65 (1997). Cf. De Kwiatkowski v. Bear, Stearns & Co., 306 F.3d 1293, 1302-03, 1308-09 (2d Cir. 2002) (noting that brokers normally have no ongoing duty to monitor nondiscretionary accounts but that “special circumstances,” such as a broker's de facto control over an unsophisticated client's account, a client's impaired faculties, or a closer-than-arms-length relationship between broker and client, might create extra-contractual duties).

, might create extra-contractual duties).

We request comment generally on the investor protection implications of a rule excepting fee-based brokerage accounts from the Advisers Act. What investor protections would be lost or gained under the rule? Commenters should address how fee-based brokerage offers brokerage customers the potential for additional protections over commission-based brokerage. Are broker-dealers' and their representatives' interests better aligned with those of their customers in such arrangements? Would the realignment of economic incentives accomplish substantially more for these customers than application of an additional investment advisory regulatory regime with its attendant costs?

While fee-based brokerage accounts eliminate certain conflicts of interest that broker-dealer representatives have with their customers, we recognized 55 Would broker-dealers' lack of compliance with the NASD notice suggest that we ought not adopt this rule? On the other hand, does the NASD's action suggest that appropriate actions are being taken?

55 NASD Notice to Members (Nov. 23, 2004). Our staff examinations of broker-dealers offering fee-based programs suggest that not all NASD members may be complying with the advice provided by this notice and may be in violation of NASD rules identified in the notice. The NASD is addressing these matters.

3. Package of Services

In our Proposing Release, we suggested that broker-dealers offering fee-based brokerage were merely re-pricing their existing brokerage accounts. Information provided to us by our staff indicates, however, that some broker-dealers today offer a different mix of services within the traditional package of services (including, for example, a different level of investment advice) to fee-based accounts than they offer to commission-based accounts. When brokers re-price traditional commission-based brokerage accounts, they create a different set of incentives for their registered representatives

however, that some broker-dealers today offer a different mix of services within the traditional package of services (including, for example, a different level of investment advice) to fee-based accounts than they offer to commission-based accounts. When brokers re-price traditional commission-based brokerage accounts, they create a different set of incentives for their registered representatives. Thus, it is not surprising to us, nor is it inconsistent with the design of the rule we are today reproposing, that customers with fee-based brokerage accounts may obtain a different level or quality of services, within the traditional package of services (including a different level or quality of advisory services), than do customers with commission-based brokerage accounts. Indeed, one of the aims of the Tully Committee, as articulated in its report, was to create incentives for brokers to improve the quality of the advisory services provided their customers. 56

56 See Tully Report, supra note 13, at 11.

If commission-based brokerage accounts receive differing levels of service depending upon the extent to which customers trade securities, it would seem to follow that fee-based brokerage accounts would receive varying levels of service depending upon the amount of assets held in the accounts. We request comment on this observation. Should differences in the nature of services provided be relevant to our consideration in deciding whether to adopt the rule?

4. Competitive Implications

to adopt the rule?

4. Competitive Implications

As we noted above, many financial planners expressed concern for the competitive implications of the rule because they would generally be subject to the Advisers Act, while broker-dealers would not. 57 Broker-dealers and investment advisers have historically provided similar advisory services and competed for similar clients seeking similar advice. The steps many commenters urged us to take—such as prohibiting broker-dealers from advertising advisory services entirely—would restrict the ability of broker-dealers to compete for customers based on advisory services the customers may be seeking.

57 See, e.g., Comment Letter of Dan Jamieson (June 1, 2000); Comment Letter of Joel P. Bruckenstein (May 31, 2000); Comment Letter of Margaret Lofaro (May 8, 2000); Comment Letter of Shawnee Barbour (Sept. 13, 2004); Comment Letter of Roselyn Wilkinson (Sept. 13, 2004); Comment Letter of Robert J. Lindner (Sept. 14, 2004); Comment Letter of Robert Lawson (Sept. 16, 2004); Patchett Letter, supra note 27; Comment Letter of John Ellison (Sept. 20, 2004); Comment Letter of Connie Brezik (Sept. 18, 2004); Comment Letter of Keven M. Doll (Sept. 20, 2004); Comment Letter of Phoebe M. White (Sept. 20, 2004); Comment Letter of Eric G. Shisler (Sept. 20, 2004); Comment Letter of Jami M. Thornton (Sept. 20, 2004); see also Comment Letter of Consumer Federation of America (Feb. 28, 2000) (“CFA Feb. 28, 2000 Letter”).

America (Feb. 28, 2000) (“CFA Feb. 28, 2000 Letter”).

Broker-dealers are subject to our oversight under the Exchange Act, as well as oversight by one or more self-regulatory organizations, to which they must pay membership dues. The SRO rules require broker-dealers to comply with numerous detailed regulatory requirements, as well as general requirements that brokers treat their customers fairly. 58 Although, as commenters pointed out, the Advisers Act contains some restrictions, and thus imposes some costs on investment advisers that are not a part of broker-dealer regulation, broker-dealer regulation is much more detailed and involves significantly more regulatory costs than investment adviser regulation.

58 See supra note 52.

We seek comment on the competitive implications of the rule for investment advisers as well as broker-dealers. To what extent should we be guided by those competitive considerations? To what extent should broker-dealers be permitted to compete for business based on the advisory services they provide that are incidental to their brokerage business?

5. Regulatory Approach

Our reproposed rule would deem broker-dealers offering fee-based brokerage accounts not to be investment advisers because they are not intended to be covered by the Advisers Act. 59 As a result, broker-dealers, at least with respect to accounts covered by the rule, would not be subject to any of the provisions of the Act. We request comment whether we should take an alternate approach under which we would use our authority in section 206A to exempt broker-dealers from provisions of the Act, such as the registration requirements, with respect to these accounts

Advisers Act. 59 As a result, broker-dealers, at least with respect to accounts covered by the rule, would not be subject to any of the provisions of the Act. We request comment whether we should take an alternate approach under which we would use our authority in section 206A to exempt broker-dealers from provisions of the Act, such as the registration requirements, with respect to these accounts. 60 What advantages do commenters view this alternative approach as providing? Are there costs? If we were to adopt a rule based on this approach, from which provisions of the Act or rules thereunder, such as the registration requirements of section 203 of the Act, should broker-dealers offering fee-based brokerage accounts be exempt with respect to those accounts? For example, should broker-dealers offering fee-based accounts be exempted from the principal trading prohibitions in the Act?

59 We are reproposing rule 202(a)(11)-1 pursuant to our authority under section 202(a)(11)(F) to except “such other persons not within the intent of” the definition of “investment adviser” in section 202(a)(11). We are also relying on our authority under section 211(a) of the Act “to classify persons and matters within [our] jurisdiction and prescribe different requirements for different classes or persons or matters.” A new classification we are making here is broker-dealers who provide investment advice solely incidental to traditional brokerage services for a fee—a group which, as discussed above, could not have existed at the time Congress enacted the Advisers Act because, in 1940, broker-dealers were paid only fixed commissions for traditional brokerage services. Such broker-dealers are therefore “other persons” within the meaning of section 202(a)(11)(F) or “different * * * persons” within the meaning of section 211(a)

ional brokerage services for a fee—a group which, as discussed above, could not have existed at the time Congress enacted the Advisers Act because, in 1940, broker-dealers were paid only fixed commissions for traditional brokerage services. Such broker-dealers are therefore “other persons” within the meaning of section 202(a)(11)(F) or “different * * * persons” within the meaning of section 211(a). In addition, section 206A of the Act permits us to exempt persons, conditionally or unconditionally from any provision of the Act or our rules to the extent such exemption is “necessary or appropriate in the public interest and consistent with the protection of investors and the purposes fairly intended by the policy and provisions of this title.”

60 Under this approach, broker-dealers offering fee-based brokerage programs would be investment advisers within the meaning of section 202(a)(11) of the Act, although exempt from certain provisions of the Act, such as the registration provisions.

B. Exception for Fee-Based Brokerage Accounts

Under reproposed rule 202(a)(11)-1(a), a broker-dealer providing

1. Investment Discretion

Under the reproposed rule, a broker or dealer relying on the exception may not “exercise investment discretion,” as that term is defined in section 3(a)(35) of the Exchange Act, 61 over the accounts from which it receives special compensation. 62 Discretionary accounts that are charged an asset-based fee or a flat fee would be considered advisory accounts because they bear a strong resemblance to traditional advisory accounts, and it is highly likely that investors will perceive such accounts to be advisory accounts. Fee-based discretionary accounts were clearly the type of accounts that Congress understood would be covered by the Advisers Act when it passed the Act in 1940.

61 15 U.S.C. 78c(a)(35)

a flat fee would be considered advisory accounts because they bear a strong resemblance to traditional advisory accounts, and it is highly likely that investors will perceive such accounts to be advisory accounts. Fee-based discretionary accounts were clearly the type of accounts that Congress understood would be covered by the Advisers Act when it passed the Act in 1940.

61 15 U.S.C. 78c(a)(35). Under section 3(a)(35) of the Exchange Act, a person exercises “investment discretion” with respect to an account if, “directly or indirectly, such person (A) is authorized to determine what securities or other property shall be purchased or sold by or for the account, (B) makes decisions as to what securities or other property shall be purchased or sold by or for the account even through some other person may have responsibility for such investment decisions, or (C) otherwise exercises such influence with respect to the purchase and sale of securities or other property by or for the account as the Commission, by rule, determines, in the public interest or for the protection of investors, should be subject to the operation of the provisions of this title and the rules and regulations thereunder.”

62 Rule 202(a)(11)-1(a)(1).

Most broker-dealer commenters thought that the rule drew the appropriate line, although one commenter expressed concern that the rule's exclusion of fee-based discretionary accounts would provide a disincentive for brokers to offer a fee-based alternative to commission-based discretionary accounts that could be offered without subjecting the broker-dealer to the Advisers Act. 63 Many commenters opposed to the proposed rule were concerned that the Commission would, in effect, abandon the “bright-line” test that “special compensation” provided for when an account should be treated as an advisory account. 64

63 Paine Webber Letter, supra note 36.

64 T. Rowe Price Jan. 14, 2000 Letter, supra note 33; Federated Letter, supra note 28; FPA Jan. 14, 2000 Letter, supra note 23. See also FPA Dec

posed to the proposed rule were concerned that the Commission would, in effect, abandon the “bright-line” test that “special compensation” provided for when an account should be treated as an advisory account. 64

63 Paine Webber Letter, supra note 36.

64 T. Rowe Price Jan. 14, 2000 Letter, supra note 33; Federated Letter, supra note 28; FPA Jan. 14, 2000 Letter, supra note 23. See also FPA Dec. 7, 2001 Letter, supra note 33.

As we discuss above, we do not believe that “special compensation” was included in section 202(a)(11)(C) for any purpose beyond readily identifying advice that was clearly not provided as part of the package of traditional brokerage services, i.e. , advice that was clearly not incidental to the brokerage services. 65 In 1940, broker-dealers were paid only fixed commissions for the traditional package of services (including investment advice) that Congress intended to except from coverage of the Act. 66 Because Congress understood “special compensation” to mean non-commission compensation, 67 the “special compensation” limitation in section 202(a)(11)(C) reliably identified advisory services that Congress intended the Advisers Act to cover. That is no longer true. Unlike in 1940, broker-dealers are no longer prohibited by SRO rules from charging a fee for the same package of brokerage services (including investment advice) that formerly could be paid for only by commissions and only recently have broker-dealers started charging these new sorts of fees. These developments could not have been foreseen in 1940, and the “bright line” that Congress identified 60 years ago has ceased to accomplish its original purpose. Permitting broker-dealers to provide nondiscretionary advice may provide a workable “bright line,” and it will not operate to extend the exception beyond the intent of Congress because in all circumstances this advice must be solely incidental to the brokerage services provided.

65 See supra note 46

bright line” that Congress identified 60 years ago has ceased to accomplish its original purpose. Permitting broker-dealers to provide nondiscretionary advice may provide a workable “bright line,” and it will not operate to extend the exception beyond the intent of Congress because in all circumstances this advice must be solely incidental to the brokerage services provided.

65 See supra note 46.

66 Until 1975, the New York Stock Exchange and the other stock exchanges required their members to charge a fixed commission on every transaction. See generally Securities Exchange Act Release No. 11203 (Jan. 23, 1975) [40 FR 7394 (Jan. 23, 1975)] (adopting Exchange Act rule 19b-3 [17 CFR 19b-3] which eliminated the fixed commission rate structure on national securities exchanges).

67 S. REP. NO. 76-1775, supra note 8, at 22; H.R. REP. NO. 76-2639, supra note 43, at 28.

We request comment on this condition of the rule. Is “discretionary authority” a workable “bright line” test? Are there alternate tests that would be more appropriate? What are they?

2. Solely Incidental To

Reproposed rule 202(a)(11)-1 would require that the advisory services provided in reliance on the exception must be solely incidental to the brokerage services provided. 68 The provision, which was included in our original proposal from 1999, was designed to preserve the “solely incidental to” requirement in section 202(a)(11)(C), although it is somewhat narrower in that it would require that advice the broker-dealer provides must be solely incidental to brokerage services provided by the broker-dealer to each account rather than the overall operations of the broker-dealer. Commenters did not disagree with this element, but urged that we provide more guidance on when advice is solely incidental to brokerage services. Section III of this Release includes a discussion of when advice is “solely incidental to” brokerage and requests comment on the application of this analysis to particular broker-dealer practices

t rather than the overall operations of the broker-dealer. Commenters did not disagree with this element, but urged that we provide more guidance on when advice is solely incidental to brokerage services. Section III of this Release includes a discussion of when advice is “solely incidental to” brokerage and requests comment on the application of this analysis to particular broker-dealer practices.

68 Rule 202(a)(11)-1(a)(1)(ii).

3. Customer Disclosure

We propose to require that all advertisements for an account excepted under rule 202(a)(11)-1(a) and all agreements, contracts, applications and other forms governing the operation of a fee-based brokerage account contain a prominent statement that the account is a brokerage account and not an advisory account. In addition, the disclosure must explain that, as a consequence, the customer's rights and the firm's duties and obligations to the customer, including the scope of the firm's fiduciary obligations, may differ. Finally, broker-dealers must identify an appropriate person at the firm with whom the customer can discuss the differences.

Our original proposal would have required broker-dealers to disclose only that the fee-based accounts are brokerage accounts. We received a great deal of comment that this disclosure was inadequate to permit customers and prospective customers to understand the differences between advisory and brokerage accounts, including the differences in fiduciary duties owed to investors by advisers and brokers. 69 In

69 E.g. , ICAA Sept. 22, 2004 Letter, supra note 28; AICPA Sept. 22, 2004 Letter, supra note 26; FPA Jan. 14, 2000 Letter, supra note 23; ICAA Jan. 12, supra note 23; Comment Letter of Walter R. Greenfield (Jan. 4, 2000).

r, supra note 28; AICPA Sept. 22, 2004 Letter, supra note 26; FPA Jan. 14, 2000 Letter, supra note 23; ICAA Jan. 12, supra note 23; Comment Letter of Walter R. Greenfield (Jan. 4, 2000).

We recognize that there may be a tension between the amount of information required in a legend and the likelihood of investors reading and understanding the information. Shorter disclosure may be more effective. Because it is impracticable to include all of the many possible differences between advisory and brokerage accounts in a brief disclosure, we have proposed an approach to encourage investors to discuss the differences with appropriate brokerage personnel. Is our proposed disclosure appropriate? Will it effectively serve its intended purposes? Should we require additional information to be disclosed? If so, what should that information be? Is the proposed disclosure too long to be practicable in an advertisement? If so, what should we omit? Will investors understand the terms we have used and their significance? If not, what terms should we use? Should materials specify who the appropriate person at their firm is who can discuss the differences between an advisory and a brokerage account? Should we designate the level of seniority the person should have? Given the complexity of the concepts involved, should we consider alternatives to disclosure? If so, what alternatives should we consider?

olved, should we consider alternatives to disclosure? If so, what alternatives should we consider?

The legend would be required only on documents offering fee-based brokerage programs because only broker-dealers offering those programs would be relying on the rule. But many commenters suggested to us that the confusion between brokerage and advisory accounts is not limited to fee-based brokerage. If that is the case, what is the appropriate vehicle to address this confusion? For example, should we request the broker-dealer self regulatory organizations to consider disclosure requirements that have broader application, including requiring disclosure on broker-dealer documents that do not offer or govern fee-based brokerage accounts?

C. Discretionary Asset Management

As discussed above, the exception for broker-dealers offering fee-based brokerage accounts would be available only if the broker-dealer does not exercise discretionary authority over the account. We recognized in the Proposing Release the existence of a regulatory anomaly that the proposed rule would create. Broker-dealers that manage discretionary accounts for which they receive commissions or dealer-based compensation may not receive any “special compensation.” If managing a discretionary account can be viewed as solely incidental to the brokerage business, then a broker-dealer paid through commissions or dealer-based compensation could rely on the statutory exception and need not treat the account as an advisory account. Under this view, a regulatory distinction would continue to be drawn based solely on the form the broker-dealer's compensation takes. This result seemed inconsistent with our intent in designing the proposed rule. In the Proposing Release, we requested comment on whether we should require broker-dealers to treat all discretionary accounts as advisory accounts, without regard to the form of the broker-dealer's compensation. 70

70 Proposing Release, supra note 5

wn based solely on the form the broker-dealer's compensation takes. This result seemed inconsistent with our intent in designing the proposed rule. In the Proposing Release, we requested comment on whether we should require broker-dealers to treat all discretionary accounts as advisory accounts, without regard to the form of the broker-dealer's compensation. 70

70 Proposing Release, supra note 5. The Commission received over 50 comment letters in response to this request for comments.

Many broker-dealers who responded to this request for comment urged that we continue to permit broker-dealers offering discretionary brokerage accounts for commissions or dealer-based compensation to avail themselves of the statutory broker-dealer exception. 71 Some argued that these accounts were made available as an accommodation to customers who understood the nature of the accounts, and that any additional regulatory protections provided by the Advisers Act would be redundant to those already provided by broker-dealer regulation. 72 Many other commenters, however, including those representing investment advisers, argued that discretionary brokerage accounts are indistinguishable from advisory accounts and urged us to apply the Advisers Act and the rules thereunder to both. 73 Some, including one large broker-dealer, asserted that discretion was a key distinguishing feature of an advisory account and therefore all discretionary accounts should be regulated as advisory accounts. 74 Others argued that broker-dealers exercising discretionary authority would actually be providing advice that is not solely incidental to brokerage, and thus should not have available the broker-dealer exception in section 202(a)(11)(C). 75

okerage, and thus should not have available the broker-dealer exception in section 202(a)(11)(C). 75

71 E.g., Comment Letter of Paine Webber Incorporated (Jan. 14, 2000) (“Paine Webber Letter”); Comment Letter of Smith Barney Citigroup (Jan. 14, 2000) (“Smith Barney Letter”); Comment Letter of First Dallas Securities” (Jan. 13, 2000) (“First Dallas Letter”); Comment Letter of Stephens, Inc. (Jan. 12, 2000) (“Stephens Letter”). See also Comment Letter of Securities Industry Association (Jan. 13, 2000); Comment Letter of National Association of Securities Dealers (Feb. 24, 2000). But see Comment Letter of Charles Schwab & Co. (Sept. 22, 2004); Comment Letter of TD Waterhouse Investor Services, Inc. (Sept. 22, 2004).

72 See Stephens Letter, supra note 71; First Dallas Letter, supra note 71; Smith Barney Letter, supra note 71.

73 E.g., Comment Letter of T. Rowe Price Associates, Inc. (Jan. 14, 2000) (“T. Rowe Price Jan. 14, 2000 Letter”); FPA Jan. 14, 2000 Letter, supra note 23; Comment Letter of North American Securities Administrators Association, Inc. (Jan. 14, 2000) (“NASAA Jan. 14, 2000 Letter”); ICAA Jan. 12, 2000 Letter, supra note 23. See also AICPA Sept. 22, 2004 Letter, supra note 26.

74 Charles Schwab Sept. 22, 2004 Letter, supra note 71. See also T. Rowe Price Jan. 14, 2000 Letter, supra note 73; NASAA Jan. 14, 2000 Letter, supra note 73; ICAA Jan. 12, 2000 Letter, supra note 30.

75 See, e.g., Comment Letter of AARP (Nov. 17, 2003) (“AARP Letter”); FPA Jan. 14, 2000 Letter, supra note 23; T. Rowe Price Jan. 14, 2000 Letter, supra note 73. See also ICAA Jan. 12, 2000 Letter, supra note 23; NASAA Jan. 14, 2000 Letter, supra note 73.

n. 14, 2000 Letter, supra note 73. See also ICAA Jan. 12, 2000 Letter, supra note 23; NASAA Jan. 14, 2000 Letter, supra note 73.

We have not previously interpreted the scope of section 202(a)(11)(C) to preclude a broker-dealer from exercising discretionary authority over the accounts of a limited number of its customers as long as the customers did not pay special compensation for these services. In 1978, however, we expressed concern that brokerage relationships “which include discretionary authority to act on a client's behalf have many of the characteristics of the relationships to which the protections of the Advisers Act are important,” and we requested comment on whether we should take action to require that these accounts be treated as advisory accounts. 76 After considering the issue, we determined not to take action at that time on whether discretionary accounts should be treated as advisory accounts but explained that our staff would continue to examine the applicability of the federal securities laws to discretionary accounts. 77 We further stated that “the staff would continue to take the position that brokers or dealers who exercise discretion over a limited number of their customers' accounts, but do not receive special compensation for such services, can rely on the exception in section 202(a)(11)(C).” 78

76 Investment Advisers Act Release No. 626, supra note 5.

77 Applicability of the Investment Advisers Act to Certain Brokers and Dealers, Investment Advisers Act Release No. 640 (Oct. 5, 1978) [43 FR 47176 (Oct. 13, 1978)] (“Advisers Act Release No. 640”).

78 Id

omers' accounts, but do not receive special compensation for such services, can rely on the exception in section 202(a)(11)(C).” 78

76 Investment Advisers Act Release No. 626, supra note 5.

78 Id.

After reviewing the many comment letters we received on this matter, and exploring this issue anew in the context of this rulemaking, we are proposing a rule stating that discretionary investment advice, as that term is defined in section 3(a)(35) of the Exchange Act, is not “solely incidental 79

79 Adoption of Amendments to Rule 206A-1(T) under the Investment Advisers Act of 1940 Extending the Duration and Limiting the Scope of the Temporary Exemption from the Advisers Act for Certain Brokers and Dealers, Investment Advisers Act Release No. 471 (Aug. 20, 1975) (“Advisers Act Release No. 471”).

Although we did not require that all discretionary accounts be treated as advisory accounts when the issue was presented in 1978, we and our staff have long acknowledged that a broker-dealer's exercise of investment discretion over customer accounts raises serious questions about whether such accounts must be treated as subject to the Advisers Act—even where no special compensation is received. 80 Since at least 1978, the staff has viewed the exercise of investment discretion in commission-based accounts as a critical factor in determining whether a broker-dealer could rely on the exception provided by section 202(a)(11)(C)

customer accounts raises serious questions about whether such accounts must be treated as subject to the Advisers Act—even where no special compensation is received. 80 Since at least 1978, the staff has viewed the exercise of investment discretion in commission-based accounts as a critical factor in determining whether a broker-dealer could rely on the exception provided by section 202(a)(11)(C). 81 Indeed, broker-dealers have known for decades that “if the business of a broker or dealer consists almost exclusively of managing accounts on a discretionary basis, the [Division of Investment Management] would not regard such broker or dealer as providing investment advice solely incidental to his business as a broker or dealer and therefore the broker or dealer would not be eligible for the [exception] in section 202(a)(11)(C).” 82

80 See supra note 76 and accompanying text.

81 Advisers Act Release No. 640, supra note 76.

82 Id.

The rule we propose today would supersede this existing staff approach, under which a discretionary account is subject to the Advisers Act only if the broker-dealer has enough other discretionary accounts to trigger the Act. Under proposed rule 202(a)(11)-1(b), the exception provided by section 202(a)(11)(C) would be unavailable for any account over which a broker-dealer exercises investment discretion, without regard to how the broker-dealer handles other accounts. We believe that such an approach may be preferable for several reasons. First, it better ensures that the Advisers Act is applied where investors have the sort of relationship with a broker-dealer that we have long recognized the Act was intended to reach. 83 Second, it is consistent with the longstanding view, which would be codified in reproposed rule 202(a)(11)-1(c), that a broker-dealer is an investment adviser solely with respect to those accounts for which the broker-dealer provides services or receives compensation that subject the broker-dealer to the Advisers Act

th a broker-dealer that we have long recognized the Act was intended to reach. 83 Second, it is consistent with the longstanding view, which would be codified in reproposed rule 202(a)(11)-1(c), that a broker-dealer is an investment adviser solely with respect to those accounts for which the broker-dealer provides services or receives compensation that subject the broker-dealer to the Advisers Act. Third, unlike the existing staff approach, the proposed rule provides a bright-line test for the availability of the section 202(a)(11)(C) exception. It thereby clarifies that provision at a time when the line between advisory and brokerage services is blurring and the original “bright line” of special compensation has ceased to function as a reliable indicator of the services the Act was designed to reach. Finally, the proposed interpretation would result in all discretionary accounts being treated as advisory accounts without regard to the form of broker compensation and would therefore be consistent with the design of reproposed rule 202(a)(11)-1 as a whole.

83 Advisers Act Release No. 471, supra note 79.

We understand that, on occasion, a broker-dealer may exercise limited discretion over a customer account for a brief period of time ( e.g., when a customer is on vacation). Should such an isolated or occasional exercise of discretion cause a broker-dealer to lose its ability to rely on the exception? Should we consider other exceptions? 84 Should we include any or all exceptions in the rule text?

84 We note, for example, that NASD Rule 2510(d) sets forth certain exceptions to the NASD rule governing discretionary accounts ( e.g., discretion as to the price at which or the time when an order given by a customer for the purchase or sale of a definite amount of a specified security shall be executed not subject to rules governing discretionary accounts)

y or all exceptions in the rule text?

We request comment on this interpretation, and the use of “discretionary advice” as a bright line test to identify those brokerage accounts that must be treated as advisory accounts. We propose to use the definition of investment discretion in section 3(a)(35) of the Exchange Act and we request comment on using this definition. Is some other definition more appropriate? If so, what definition should we use?

We understand that many broker-dealers today treat discretionary accounts as advisory accounts. Is this understanding correct? Do many broker-dealers also treat discretionary accounts as brokerage accounts? Do broker-dealers maintain both types of accounts, and if so, what are the determinative factors for classifying an account as an advisory or brokerage account? What impact on broker-dealers would our interpretation have? We are particularly interested in learning whether most broker-dealers that do not treat discretionary accounts as advisory accounts are already registered under the Advisers Act for other reasons.

interested in learning whether most broker-dealers that do not treat discretionary accounts as advisory accounts are already registered under the Advisers Act for other reasons.

We are also interested in understanding the impact on investors of these distinctions. As we acknowledged in the Proposing Release, investors are often confused by the differences between advisory and brokerage accounts. Would the distinction we propose to draw between discretionary and non-discretionary accounts resolve at least some of that that confusion?

Does the legislative history of section 202(a)(11)(C) support our proposed rule? Although in 1940 many broker-dealers exercised discretion over the accounts they serviced for a fee through separate advisory departments in their firms, broker-dealers were generally disinclined to accept such discretionary advisory accounts, 85 and the extent to which broker-dealers were exercising discretion over commission-based customer accounts outside of separate advisory departments is unclear. As a result, we are unable to conclude that in 1940 Congress would have understood investment discretion to be part of the traditional package of services broker-dealers offered for commissions. We are aware of nothing in the legislative history of section 202(a)(11)(C) (or of the Act as a whole) or in the brokerage practices in 1940 that would preclude our interpretation of that section as being unavailable for all accounts over which broker-dealers exercise investment discretion. 86 There is no

85 SECURITY MARKETS, supra note 39, at 649-650.

86 In the decade preceding the enactment of the Advisers Act, both the New York Stock Exchange and the Commission promulgated measures designed to regulate and, in the case of the NYSE rules, to significantly limit the exercise of investment discretion by broker-dealers. The NYSE prohibited customers' men from handling discretionary accounts; with few exceptions, only partners were authorized to handle such accounts

eceding the enactment of the Advisers Act, both the New York Stock Exchange and the Commission promulgated measures designed to regulate and, in the case of the NYSE rules, to significantly limit the exercise of investment discretion by broker-dealers. The NYSE prohibited customers' men from handling discretionary accounts; with few exceptions, only partners were authorized to handle such accounts. SECURITY MARKETS, supra note 39, at 638-40. See also Wall St. Problem in Customers' Men, N.Y. Times, Jan. 14, 1934, at N7 (“[T]he Stock Exchange has approved rules prohibiting customers' men from handling discretionary accounts, which powers are now delegated with few exceptions, only to partners in Stock Exchange firms.”). In

Commenters asserting that discretionary authority is not an appropriate means of drawing a line in the case of commission-based accounts should address whether it draws an appropriate line for fee-based accounts. Is reproposed rule 202(a)(11)-1 as a whole appropriate in light of our reliance in the rule on the distinction between discretionary and non-discretionary authority?

D. Discount Brokerage Programs

We are also reproposing, as part of rule 202(a)(11)-1, a provision that a broker-dealer will not be considered to have received special compensation solely because the broker-dealer charges a commission, mark-up, mark-down or similar fee for brokerage services that is greater than or less than one it charges another customer. 87 This provision is intended to keep a full-service broker-dealer from being subject to the Advisers Act solely because it also offers electronic trading or other forms of discount brokerage. Conversely, a discount broker-dealer would not be subject to the Act solely because it introduces a full-service brokerage program.

87 Rule 202(a)(11)- 1(a)(2)

or less than one it charges another customer. 87 This provision is intended to keep a full-service broker-dealer from being subject to the Advisers Act solely because it also offers electronic trading or other forms of discount brokerage. Conversely, a discount broker-dealer would not be subject to the Act solely because it introduces a full-service brokerage program.

87 Rule 202(a)(11)- 1(a)(2).

The rule, if adopted, would supersede staff interpretations under which a full-service broker-dealer is subject to the Advisers Act with respect to accounts for which it provided advice incidental to its brokerage business merely because it offers electronic trading or other form of discount brokerage. 88 These staff interpretations led to the odd result that a full-service broker-dealer cannot offer discount brokerage without treating its full-service brokerage accounts as advisory accounts even though the services offered to those accounts remained unchanged. Moreover, these staff interpretations may create disincentives for full-service broker-dealers to offer electronic or other types of discount brokerage, and thus may limit customers' choices of types of brokerage service, and may reduce competition in discount brokerage. The reproposed rule makes a broker-dealer's eligibility for the broker-dealer exception with respect to an account turn on the characteristics of that particular account and not of other accounts the broker-dealer may also service. Commenters discussing this aspect of the proposed rule generally supported it, 89 and we are reproposing it without change. Do commenters continue to support this provision? Should we consider any modifications to this provision?

88 See Advisers Act Release No. 2, supra note 3.

89 Federated Letter, supra note 28; Comment Letter of Charles Schwab & Co. (Jan. 14, 2000); Comment Letter of NASD (Feb. 24, 2000).

ing this aspect of the proposed rule generally supported it, 89 and we are reproposing it without change. Do commenters continue to support this provision? Should we consider any modifications to this provision?

88 See Advisers Act Release No. 2, supra note 3.

89 Federated Letter, supra note 28; Comment Letter of Charles Schwab & Co. (Jan. 14, 2000); Comment Letter of NASD (Feb. 24, 2000).

E. Scope of Exception

Reproposed rule 202(a)(11)-1 would also provide that a broker-dealer that is registered under both the Exchange Act and the Advisers Act is an investment adviser solely with respect to those accounts for which it provides services or receives compensation that subject the broker or dealer to the Advisers Act. 90 This provision would codify our earlier interpretation of the Act that permits a broker-dealer registered under the Advisers Act to distinguish its brokerage customers from its advisory clients. 91 We received few comments regarding the scope of the proposed exception, which we are reproposing without change.

90 Rule 202(a)(11)- 1(c).

91 Advisers Act Release No. 626, supra note 5.

Finally, the Commission would interpret the broker-dealer exception as being available not only to a broker-dealer, but also to any of its registered representatives, i.e., those employees and other persons whose investment advisory activities are subject to the control and supervision of the broker-dealer. 92 A registered representative who provides investment advice independent of his broker-dealer employer ( e.g., by establishing an independent financial planning practice or providing advisory services outside his capacity as a registered representative, without the control, knowledge and approval of his broker-dealer employer) could not rely on the exception because his investment advisory activities would not be solely incidental to the broker-dealer's business. 93

92 The staff's views on this matter were set forth in Advisers Act Release No. 1092, supra note 2

or providing advisory services outside his capacity as a registered representative, without the control, knowledge and approval of his broker-dealer employer) could not rely on the exception because his investment advisory activities would not be solely incidental to the broker-dealer's business. 93

92 The staff's views on this matter were set forth in Advisers Act Release No. 1092, supra note 2. See also Strevell No-Action Letter, supra note 9; Brent A. Neiser, SEC Staff No-Action Letter (pub. avail. Jan. 21, 1986) (“Neiser No-Action Letter”).

93 The staff's views on this matter were set forth in the Strevell No-Action Letter, supra note 9 and the Neiser No-Action Letter, supra note 92.

III. Proposed Statement of Interpretive Position

Many commenters urged us to provide greater guidance on when advice is solely incidental to brokerage services, observing that, in the past, most questions arising under section 202(a)(11)(C) have involved the meaning of “special compensation.” 94 A number of commenters offered suggestions of how we might further develop the interpretation of “solely incidental to.” Some supported very narrow views of what “solely incidental to” means, suggesting that it should include only advice that is a minor or insignificant part of a broker-dealer's business, 95 or advice that is not marketed by the broker. 96 Because reliance on both the rule and statute turn on whether advice provided by a broker-dealer is solely incidental to the brokerage business (or, in the case of the rule, to the brokerage services provided to the account), it is a question of substantial significance to broker-dealers.

to the account), it is a question of substantial significance to broker-dealers.

94 E.g., Comment Letter of Consumer Federation of America (Jan. 14, 2000); ICAA Jan. 12, 2000 Letter, supra note 23; T. Rowe Price Jan. 14, 2000 Letter, supra note 32; Comment Letter of Investment Company Institute (Jan. 14, 2000); U.S. Bancorp Letter, supra note 36; Letter of Connecticut Department of Banking (Jan. 20, 2000)(“Connecticut Department of Banking”); Letter of Certified Financial Planner Board of Standards (Sept. 22, 2004); Charles Schwab Sept. 22, 2004 Letter, supra note 20; NASAA Letter, supra note 31.

95 ICAA Jan 12, 2000 Letter, supra note 23, Comment Letter of T. Rowe Price Associates, Inc. (Sept. 22, 2004).

96 CFA Jan. 13, 2000 Letter, supra note 23, Connecticut Department of Banking, supra note 94, ICAA Sept. 22, 2004 Letter, supra note 28.

In general, we understand investment advice to be “solely incidental to” the conduct of a broker-dealer's business within the meaning of section 202(a)(11)(C) when the advisory services rendered to an account are in connection with and reasonably related to the brokerage services provided to that account. This understanding is consistent with the legislative history of the Advisers Act, which indicates Congress' intent to exclude broker-dealers providing advice as part of traditional brokerage services. 97 It is also consistent with the Commission's contemporaneous construction of the Advisers Act as excepting broker-dealers whose investment advice is given “solely as an incident of their regular business.” 98

97 See supra notes 40-46 and accompanying text.

98 See Investment Advisers Act Release No. 1 [11 FR 10996 (Sept. 23, 1940)] (“Release No. 1”)(emphasis added)

itional brokerage services. 97 It is also consistent with the Commission's contemporaneous construction of the Advisers Act as excepting broker-dealers whose investment advice is given “solely as an incident of their regular business.” 98

97 See supra notes 40-46 and accompanying text.

98 See Investment Advisers Act Release No. 1 [11 FR 10996 (Sept. 23, 1940)] (“Release No. 1”)(emphasis added). It is also consistent with how our staff has construed section 202(a)(11)(B) of the Act, which provides an exception for lawyers, accountants, engineers and teachers “whose performance of such services is incidental to the practice of [their] profession.” See Hungerford,

We propose to read section 202(a)(11)(C) more broadly than some commenters suggest. Those commenters read the words “solely incidental” to mean that the advice provided must be only “incidental” in the sense of “minor,” “insignificant,” “periodic,” “episodic,” or “advice about specific securities.” 99 This reading is based on the view that the statute excepts “solely incidental” advisory services instead of advisory services that are “solely incidental to” a broker-dealer's business, i.e. , advisory services that are “liable to happen as a consequence of” or “follow[] as a consequence” of the conduct of a broker-dealer's business. 100 Moreover, the view that only minor or insignificant advice is excepted by section 202(a)(11)(C) ignores the fact that the advice broker-dealers gave as part of their traditional brokerage services in 1940 was often substantial in amount and importance to the customer. 101 This has remained true throughout the following decades. 102 Indeed, the importance of the broker-dealer's role as advice-giver in connection with brokerage transactions has shaped how we and the self-regulatory organizations have regulated and continue to regulate broker-dealers

art of their traditional brokerage services in 1940 was often substantial in amount and importance to the customer. 101 This has remained true throughout the following decades. 102 Indeed, the importance of the broker-dealer's role as advice-giver in connection with brokerage transactions has shaped how we and the self-regulatory organizations have regulated and continue to regulate broker-dealers. 103 On the other hand, some commenters would interpret “solely incidental to” a broker-dealer's business to permit broker-dealers to rely on section 202(a)(11)(C) broadly to provide any or all types of advisory services as part of a brokerage account. This interpretation would have the effect of negating any limitation inherent in the “solely incidental” standard, and we propose not to read “solely incidental to” so broadly. Do commenters agree with our view? Those who disagree with us should suggest alternative interpretive approaches that find support in the intent of Congress and the legislative history of the Advisers Act, and in contemporaneous industry practice.

99 See, e.g., Comment Letter of Consumer Federation of America (Sept. 4, 2000); ICAA Sept. 22, 2004 Letter, supra note 28.

100 See Compact Oxford English Dictionary (2004) (available on the Internet http://www.dictionary.com ) (listing as synonyms of “incidental to” the words “accompanying,” “attendant,” and “concomitant”). Prior to the Act's enactment, the term “incidental” was defined to include: “Liable to happen or to follow as a chance feature or incident.” Webster's New Int'l Dictionary 1257 (unabridged 2d ed. 1934). The same dictionary defined “incident” to include “[d]ependent on, or appertaining to, another thing” or “directly and immediately pert[inent] to, or involved with, something else, though not an essential part of it.” Id. ; cf

the term “incidental” was defined to include: “Liable to happen or to follow as a chance feature or incident.” Webster's New Int'l Dictionary 1257 (unabridged 2d ed. 1934). The same dictionary defined “incident” to include “[d]ependent on, or appertaining to, another thing” or “directly and immediately pert[inent] to, or involved with, something else, though not an essential part of it.” Id. ; cf. Fowler, A Dictionary of Modern English Usage 264 (Oxford Press 1937)(stating that “while incidental is applied to side occurrences with stress on their independence of the main action,” the word “incident”—particularly “with ‘to’ as the link”—“is mostly used in close combination with whatever word may represent the main action or subject” and “implies that, though not essential to it, [the side occurrences] not merely happen to arise in connection with [the main action] but may be expected to do so” (emphasis in original).

101 See supra note 40-46 and accompanying text. It is also inconsistent with section 202(a)(11)(C) read as a whole. Following the broad description of the type of services rendered by advisers in paragraph (11)( i.e., “advising others * * * as to the value of securities or as to the advisability of investing in, purchasing or selling securities”), the provision in subparagraph (C) excepts broker-dealers “whose performance of such services is solely incidental to the conduct of the broker-dealer's business and for no special compensation” (emphasis added). This structure also supports our conclusion that the words “solely incidental to” do not operate to limit the ways in which broker-dealers can amrket their services.

mrket their services.

102 See, e.g. , Robert Bendiner, Current Quotations on Stockbrokers , N.Y. TIMES, May 10, 1953, at SM19 (“[W]hen the Korean War began * * * [c]ustomers then wanted to know whether to expect confiscatory taxes that would reduce corporate profits, how price controls might effect their securities, and whether some businesses would be squeezed out entirely for lack of materials. ‘You have to talk to them,' one broker said. ‘Buying and selling is the least part of the service we give them for our commissions.' “); SEC, SPECIAL STUDY OF THE SECURITIES MARKETS (1963) at 330 (“SPECIAL STUDY”) (“Both the volume and the variety of the written investment information and advice originated by broker-dealers, who for the most part furnish it free to their customers as part of their effort to sell securities, are impressive.”); id. at 386 (terming investment advice furnished by broker-dealers an “integral part of their business of merchandising securities” even if only “incidental” to that business); Interpretive Releases Relating to the Securities Exchange Act of 1934 and General Rules and Regulations Thereunder: Future Structure of Securities Markets (Feb. 2, 1972) [37 FR 5286, 5290 (Mar. 14, 1972)] (“In our opinion, the providing of investment research is a fundamental element of the brokerage function for which the bona fide expenditure of the beneficiary's funds is completely appropriate, whether in the form of high commissions or outright cash payments.”); TULLY REPORT, supra note 13, at 3 (“The most important role of the registered representative is, after all, to provide investment counsel to individual clients, not to generate transaction revenues.”).

nvestment counsel to individual clients, not to generate transaction revenues.”).

103 Thus, for example, under the rules of self-regulatory organizations and consistent with Commission precedent, a broker must render advice that is based on a knowledge of the security involved and that is suitable for a customer in light of the customer's needs, financial circumstances, and investment objectives. See NASD Rule 2310; NYSE Rule 405. In addition, under certain circumstances, such as when a broker-dealer assumes a position of trust and confidence with its customer, it has been held to a fiduciary standard with its customer, akin to that of an adviser and a client. See supra note 54 and accompanying text.

Many commenters urged that we declare certain current practices to be inconsistent with advice being offered solely incidental to brokerage. They believed that the Advisers Act ought to apply more broadly to full-service brokerage that is, among other things, marketed based on advisory services. 104 Before we provide any interpretive guidance that could have an effect on brokerage practices, we believe it is appropriate and useful to seek additional comment from all interested persons.

104 Letter of North American Securities Administrators Association, Inc. (Oct. 6, 2004) (“NASAA Letter”); AICPA Sept. 22, 2000 Letter, supra note 26; ICAA Sept. 22, 2004 Letter, supra note 28; Comment Letter of National Association of Personal Financial Advisors (Sept. 21, 2004) (“NAPFA Letter”); Comment Letter of Henry L. Woodward (Sept. 21, 2004); Dimitroff Letter, supra note 23; Patchett Letter, supra note 27; Heydri Letter, supra note 31; Comment Letter of Charles O'Connor (Sept. 14, 2004); Comment Letter of Consumer Federation of America (Jan. 13, 2000) (“CFA Jan. 13, 2000 Letter”); Comment Letter of Pamela A. Jones (Jan. 4, 2000)

Financial Advisors (Sept. 21, 2004) (“NAPFA Letter”); Comment Letter of Henry L. Woodward (Sept. 21, 2004); Dimitroff Letter, supra note 23; Patchett Letter, supra note 27; Heydri Letter, supra note 31; Comment Letter of Charles O'Connor (Sept. 14, 2004); Comment Letter of Consumer Federation of America (Jan. 13, 2000) (“CFA Jan. 13, 2000 Letter”); Comment Letter of Pamela A. Jones (Jan. 4, 2000).

The Commission is considering issuing an interpretive position or including some or all of its interpretations relating to “solely incidental to” in a rule when it acts on reproposed rule 202(a)(11)-1. 105 The interpretations would address the application of the “solely incidental to” requirement of section 202(a)(11)(C) of the Act and paragraph (a)(1)(ii) of rule 202(a)(11)-1 to certain common broker-dealer practices described below. Commenters should address whether, in their view, our proposed interpretations or any alternative interpretations find support in the Act or its legislative history. They should also address the costs and benefits of the proposed or any alternative interpretations. Where possible, commenters should quantify such costs and benefits. Should we apply the Advisers Act in the circumstances that we describe below in light of protections afforded investors by the Exchange Act?

105 We note that reproposed rule 202(a)(11)-1 already contains one interpretation regarding the scope of section 202(a)(11)(C). Paragraph (c) of the rule explains that under the exception, a broker-dealer is an investsment adviser only with respect to those accounts for which it provides services or receives compensation that subject the broker-dealer to the Advisers Act.

y the Exchange Act?

A. Holding Out as an Investment Adviser

In the Proposing Release we expressed concern that many broker-dealers offering fee-based brokerage accounts have marketed them heavily based on the advisory services provided rather than securities transaction services, 106 and we expressed concern about whether investors would perceive these accounts to be advisory accounts 107

106 Proposing Relese, supra note 5.

107 Investment Advisers Act Release No. 2278 (Aug. 19, 2004)[69 FR 51620 (Aug. 20, 2004)]. See Investment Advisers Act Release, supra note 2 (A lawyer or accountant who holds himself out to the public as providing financial planning, pension consulting, or other financial advisory services would not be able to rely on the exclusion in Section 202(a)(11)(B) of the Advisers Act.)

A large number of commenters expressed substantial concern that broker-dealer marketing efforts contribute to investor confusion about the differences between broker-dealers and advisers, and urged us to deny broker-dealers the ability to rely on the broker-dealer exemption if they held themselves out based on their advisory services. 108 Some of these commenters asserted that any marketing of advisory services by a broker-dealer, whether for a fee-based account or an account paying commissions, is inconsistent with those services being solely incidental to the brokerage business. These commenters expressed the view that broker-dealers should stop calling their registered representatives “financial consultants,” “financial advisors,” or similar names.

108 E.g., NASAA Letter, supra note 104; AICPA Letter, supra note 26; ICAA Sept

for a fee-based account or an account paying commissions, is inconsistent with those services being solely incidental to the brokerage business. These commenters expressed the view that broker-dealers should stop calling their registered representatives “financial consultants,” “financial advisors,” or similar names.

108 E.g., NASAA Letter, supra note 104; AICPA Letter, supra note 26; ICAA Sept. 22, 2004 Letter, supra note 28; Comment Letter of Financial Services Institute (Sept. 22, 2004); NAPFA Letter, supra note 104; FPA June 21, 2004 Letter, supra note 30; Joint Comment Letter of Consumer Federation of America, Certified Financial Planner Board of Standards, Investment Counsel Association of America and the National Association of Personal Financial Advisors (May 31, 2000); FPA Jan. 14, 2000 Letter, supra note 23); CFA Jan. 13, 2000 Letter, supra note l104.

We are addressing these concerns in our reproposal of rule 202(a)(11)-1 by proposing to require broker-dealers offering fee-based brokerage to include a prominent statement on all advertisements for, and contracts, agreements, applications and other forms governing fee-based brokerage accounts. The statement must disclose that the accounts are brokerage accounts and not advisory accounts, that, as a consequence, the customer's rights and the firm's duties and obligations to the customer, including the scope of the firm's fiduciary obligations, may differ, and must identify an appropriate person at the firm with whom the customer can discuss the differences. 109 Does this approach address investor confusion concerns? Will the disclosures make sense to investors if broker-dealers continue to refer to their registered representatives as “financial consultants” or “financial advisors”? Should we instead conclude that use by a broker-dealer of such terms is inconsistent with the broker-dealer exception?

109 Rule 202(a)(11)-1(a)(1)(iii)

the differences. 109 Does this approach address investor confusion concerns? Will the disclosures make sense to investors if broker-dealers continue to refer to their registered representatives as “financial consultants” or “financial advisors”? Should we instead conclude that use by a broker-dealer of such terms is inconsistent with the broker-dealer exception?

109 Rule 202(a)(11)-1(a)(1)(iii).

The Advisers Act also provides an exception for lawyers and accountants, and our staff has viewed the availability of that exception as turning on whether the lawyer or accountant has held himself out as providing financial planning, pension consulting, or other financial advisory services. 110 Should we apply a similar standard to broker-dealers? Would such an approach address confusion among investors as to the differences between advisory accounts and brokerage accounts? On the other hand, would applying such an approach to broker-dealers ignore salient distinctions between broker-dealers and other professionals in terms of their advice-giving role?

110 See Advisers Act Release No. 1092; supra note 2.

B. Financial Planning Services

Financial planning services typically involve preparing a financial program for a client based on the client's financial circumstances and objectives. A financial planner generally seeks to address a wide spectrum of the client's long-term financial needs, including insurance, savings, and investments, taking into consideration anticipated retirement or other employee benefits. 111 A financial planner also may develop tax or estate plans for clients or refer clients to attorneys, accountants or other professionals. In most cases, financial planners who provide advice about the advisability of investing in securities, advice about market trends, or advice about retaining an investment manager are subject to the Advisers Act. 112

111 See Jonathan R. Macey, Regulation of Financial Planners: A White Paper Prepared for the Financial Planning Association (Apr

nts to attorneys, accountants or other professionals. In most cases, financial planners who provide advice about the advisability of investing in securities, advice about market trends, or advice about retaining an investment manager are subject to the Advisers Act. 112

111 See Jonathan R. Macey, Regulation of Financial Planners: A White Paper Prepared for the Financial Planning Association (Apr. 2002) at 5 (“In short, a financial planner develops plans that address all financial aspects of an individual's life. The breadth and scope of the advice given by financial planners is what distinguishes them from other, more specialized participants in the financial services industry. Unlike stock brokers, insurance salesmen, accountants, tax planners, lawyers, and trust and estate experts, financial planners may give advice on investments, savings, taxes, insurance, retirement, estate planning, trusts, and real estate. In addition to a broad rangae of technical advice, typically important components of financial planning are the initial assessment of a clinet's overall financial, familial, personal, and professional needs and goals as well as further monitoring and revision of the client's financial plan.”).

112 See Advisers Act Release No. 1092, supra note 2. In advisers Act Release No. 1092 we published the views of our staff as to the applicability of the Advisers Act to financial planners and other persons who provide investment advice as a component of other financial services.

The advisory services provided by financial planners and the context in which they are provided may extend beyond what Congress, in 1940, reasonably could have understood broker-dealers to have provided as an advisory service ancillary to their brokerage business. 113 We are concerned that some broker-dealers have promoted “financial planning” as a way of acquiring the confidence of customers to promote their brokerage services without actually providing any meaningful financial planning

ded may extend beyond what Congress, in 1940, reasonably could have understood broker-dealers to have provided as an advisory service ancillary to their brokerage business. 113 We are concerned that some broker-dealers have promoted “financial planning” as a way of acquiring the confidence of customers to promote their brokerage services without actually providing any meaningful financial planning. 114

113 Our staff has expressed similar views in the past. See Townsend and Associates, SEC Staff No-Action Letter (Sept. 21, 1994) (advice is not incidental that is provided “as part of an overall plan that addresses the financial situation of a customer and formulates a financial plan.”) See also Investment Management & Reserach, Inc., SEC Staff No-Action Letter (Jan. 27, 1977). It is also consistent with views expressed in two of the leading treatises on invesstment advisers, See Thomas P. Lemke & Gerald T. Lins, REGULATION OF INVESTMENT ADVISERS § 1:20 (2004); Clifford E. Kirsch, INVESTMENT ADVISER REGULATION (May 2004) at 2:5:1. It may, however, be inconsistent with statements made in a few of our staff's other letters. See, e.g., Nathan & Lewis Securities, SEC Staff No-Action Letter (Mar. 3, 1988) (“Nathan & Lewis No-Action Letter”); Elmer D. Robinson, SEC Staff No-Action Letter (Dec. 6, 1985).

On the other hand, the brokerage business has evolved significantly since 1940, and it may be appropriate to consider financial planning to be part of the traditional package of services broadly understood.

114 In the Matter of Haight & Co., Inc., Securities Exchange Act Release No. 9082 (Feb. 19, 1971).

derstood.

114 In the Matter of Haight & Co., Inc., Securities Exchange Act Release No. 9082 (Feb. 19, 1971).

We request comment on whether we should interpret financial planning as not solely incidental to the brokerage business. We understand that most broker-dealers that today offer financial planning services for a separate fee treat the customers receiving such services as advisory clients. Is our understanding correct? Should we limit our interpretation to circumstances where investors separately contract for financial planning services? If so, would such an approach discourage the use of separate contracts by broker-dealers? Should we limit our interpretation to circumstances where a separate fee is charged? Should our interpretation turn on whether the financial planning services are ongoing?

Many financial planners registered under both the Advisers Act and Exchange Act are compensated exclusively from commissions received on the sale of securities, including mutual fund shares. Would an interpretation that financial planning is incidental to brokerage business permit those many financial planners to withdraw their registration under the Advisers Act? Would an interpretation

We recognize that full-service broker-dealers must consider some aspects of financial planning when determining that their recommendations are suitable. 115 We would not want our interpretation to interfere in any way with a broker's suitability analysis. In order to avoid this result, how should we draw the line between planning services that are incidental to brokerage and those that are not? Can such a line be drawn? Are there other ways to distinguish a broker-dealer's suitability analysis from an adviser's financial planning services?

115 A broker must have a reasonable basis for believing that a recommendation to buy or sell a particular security is suitable for the broker's customer considering the customer's risk tolerance, other securities holdings, financial situation, financial needs, and investment objectives

other ways to distinguish a broker-dealer's suitability analysis from an adviser's financial planning services?

At present we propose to address financial planning by issuing an interpretation stating that if a broker-dealer holds itself out as a financial planner or as providing financial planning services, 116 it cannot be considered to be giving advice that is solely incidental to brokerage. Is this approach workable? Should we also (or alternatively) attempt to identify specific types of financial planning services that would or would not be incidental to the brokerage business? We solicit comment on whether we should include any interpretation regarding financial planning in rule text. If so, are there any particular concerns raised by codification? If so, how should they be addressed? We solicit comment on these and other approaches we could take as well.

116 See supra note 110.

C. Wrap Fee Sponsorship

Broker-dealers often serve as sponsors of wrap fee programs, under which broker-dealers effect securities transactions for one or more portfolio managers, which may be independent investment advisers. 117 Although a “wrap fee” involves the receipt of “special compensation,” such broker-dealers may have available the exception provided by rule 202(a)(11)-1 if, among other things, the portfolio manager selection and asset allocation services typically provided by the broker-dealer sponsor could be viewed as solely incidental to the business of brokerage. 118 However, we have not viewed the asset allocation or portfolio manager selection advice as incidental to the brokerage transactions initiated by the portfolio manager

provided by rule 202(a)(11)-1 if, among other things, the portfolio manager selection and asset allocation services typically provided by the broker-dealer sponsor could be viewed as solely incidental to the business of brokerage. 118 However, we have not viewed the asset allocation or portfolio manager selection advice as incidental to the brokerage transactions initiated by the portfolio manager. 119 Does this interpretation continue to make sense? Should we re-affirm it? We understand that broker-dealer sponsors of wrap fee programs are today registered under the Advisers Act and treat wrap fee customers as advisory clients. Is our understanding correct?

117 Under some wrap fee programs, the broker-dealer sponsor retains discretionary authority and thus must treat its wrap fee customers as advisory clients because the broker-dealers receive special compensation and would not have available the exception provided by proposed rule 202(a)(11)-1, which is limited to non-discretionary accounts. Wrap fee programs are today often referred to as “separately managed accounts” or “separate accounts.”

118 With regard to portfolio manager selection, our staff has viewed this to be so regardless of whether such services were carried out through a wrap fee program or provided as separate services. See FPC Securities Corporation, SEC Staff No-Action Letter (Nov. 1, 1974)(staff viewed broker's advice about selection of investment advisers and monitoring advisers' performance not incidental to business of broker-dealer).

119 We have viewed broker-sponsored wrap fee programs as being subject to the Advisers Act. Disclosure by Investment Advisers Regarding Wrap Fee Programs, Investment Advisers Act Release No. 1401 (Jan. 13, 1994) [59 FR 3033 (Jan. 20, 1994)], at n.2 (proposing amendments to Form ADV); Investment Advisers Act Release No. 1411 (Apr. 19, 1994)(adopting amendments to Form ADV)[59 FR 21657 (Apr. 26, 1994)].

ave viewed broker-sponsored wrap fee programs as being subject to the Advisers Act. Disclosure by Investment Advisers Regarding Wrap Fee Programs, Investment Advisers Act Release No. 1401 (Jan. 13, 1994) [59 FR 3033 (Jan. 20, 1994)], at n.2 (proposing amendments to Form ADV); Investment Advisers Act Release No. 1411 (Apr. 19, 1994)(adopting amendments to Form ADV)[59 FR 21657 (Apr. 26, 1994)].

D. Other Interpretive Questions

Finally, we request comment whether there are other interpretive questions that have arisen under section 202(a)(11)(C) and, in particular, whether there are any questions regarding any particular advisory service that we might address in an interpretive statement.

IV. General Request for Comment

The Commission requests comment on the rule and interpretations proposed in this release, suggestions for other additions to the rule and interpretations, and comment on other matters that might be affected by the proposals contained in this release. For purposes of the Small Business Regulatory Enforcement Fairness Act of 1996, the Commission also requests information regarding the potential impact of the proposed rule and interpretations on the economy on an annual basis. Commenters should provide empirical data to support their views.

V. Cost Benefit Analysis

A. Background

The Commission is sensitive to the costs and benefits of its rules. Under the proposed rule, broker-dealers would not be deemed to be investment advisers with respect to accounts for which they receive asset-based fees, fixed fees, or similar non-commission compensation, provided that: (i) They do not exercise investment discretion over the account, (ii) their investment advice is solely incidental to the brokerage services provided to the account, and (iii) they make certain disclosures in their advertising and agreements for such accounts

dvisers with respect to accounts for which they receive asset-based fees, fixed fees, or similar non-commission compensation, provided that: (i) They do not exercise investment discretion over the account, (ii) their investment advice is solely incidental to the brokerage services provided to the account, and (iii) they make certain disclosures in their advertising and agreements for such accounts. The rule would also clarify that broker-dealers are not subject to the Advisers Act solely because, in addition to full-service brokerage services, they also offer discount brokerage services, including execution-only brokerage, for reduced commission rates. These provisions of the proposed rule are designed to permit broker-dealers to offer these new types of fee-based and discount brokerage programs without triggering regulation under the Advisers Act.

The proposed rule would also specify that broker-dealers exercising investment discretion over customer accounts are not providing advice that is solely incidental to their business as brokers or dealers, regardless of the form of compensation. Thus, broker-dealers providing discretionary brokerage would not be eligible for the Advisers Act broker-dealer exception with respect to discretionary accounts, and would be subject to the Act and its requirements for those accounts.

The Commission is also proposing to interpret the application of the “solely incidental to” requirement of section 202(a)(11)(C) of the Advisers Act to certain broker-dealer practices. A broker-dealer holding itself out as a financial planner would not be considered to be providing advice that is solely incidental to its brokerage services, and thus would be subject to the Advisers Act with respect to accounts offering such advisory services.

We have identified certain costs and benefits, which are discussed below, that may result from the proposed rule and interpretations. 120 We request comment on the costs and benefits of the proposed rule and interpretations

providing advice that is solely incidental to its brokerage services, and thus would be subject to the Advisers Act with respect to accounts offering such advisory services.

120 In 1999, our Proposing Release also analyzed the costs and benefits of our first proposal to keep broker-dealers from being subject to the Advisers Act solely as a result of re-pricing their full-service brokerage services. As discussed below, the comments on our 1999 proposal have informed our analysis in preparing this cost benefit analysis.

B. Discussion

1. Fee-based and Discount Brokerage Accounts

a. Benefits

i. Avoidance of Compliance Costs

Proposed rule 202(a)(11)-1(a) would keep broker-dealers from being subject to the Advisers Act as a result of charging asset-based fees instead of commissions for accounts receiving the

Broker-dealers relying on the proposed rule with respect to these fee-based and discount brokerage programs would benefit in the form of saved costs they would otherwise expend in connection with Advisers Act compliance. 121 Broker-dealers, even those already dually-registered as investment advisers, would benefit in the form of costs saved by not having to convert their fee-based and full-service brokerage accounts into advisory accounts. For example, these accounts would not be subject to brochure delivery or other disclosure requirements under the Advisers Act. Similarly, such accounts also would not be subject to the principal trading restrictions under the Act. Securities markets would also benefit because the rule would preserve the ability of broker-dealers to engage in principal transactions with these fee-based brokerage customers, and principal transactions are a major source of market liquidity

ther disclosure requirements under the Advisers Act. Similarly, such accounts also would not be subject to the principal trading restrictions under the Act. Securities markets would also benefit because the rule would preserve the ability of broker-dealers to engage in principal transactions with these fee-based brokerage customers, and principal transactions are a major source of market liquidity. 122 Commenters responding to our Proposing Release noted a large increase in the number of fee-based brokerage programs in the years since the Proposing Release. 123 The benefits of these compliance cost savings and market liquidity are difficult to quantify. 124

121 In the alternative, broker-dealers could revert to charging commissions instead of asset-based fees, and cease offering discount brokerage services, thereby avoiding compliance costs under the Advisers Act. Given the growing popularity of these accounts, however, as discussed infra note 123, and the fact that most broker-dealers offering these accounts have already established (or an affiliate has established) a compliance infrastructure under the Advisers Act, we expect that, absent the exception that would be provided under proposed rule 202(a)(11)-(1)(a), broker-dealers would continue offering fee-based accounts and treat the accounts as advisory accounts.

122 See Section II.A.1. of this Release, supra.

123 Although commenters on our Proposing Release did not quantify this increase, one consulting firm estimates that assets in fee-based brokerage programs grew by 33.7% from the second quarter of 2003 to the second quarter of 2004. Cerulli Edge 3rd Quarter, supra note 47.

124 Commenters on our 1999 Proposing Release did not provide data quantifying the potential costs of treating such a large number of accounts as advisory accounts.

Other broker-dealers relying on the proposed rule would not be subject to the Advisers Act at all

okerage programs grew by 33.7% from the second quarter of 2003 to the second quarter of 2004. Cerulli Edge 3rd Quarter, supra note 47.

124 Commenters on our 1999 Proposing Release did not provide data quantifying the potential costs of treating such a large number of accounts as advisory accounts.

Other broker-dealers relying on the proposed rule would not be subject to the Advisers Act at all. For these broker-dealers whose fee-based or discount brokerage programs would otherwise require adviser registration, we believe the rule's benefits would be significant in terms of avoiding an increased regulatory burden incurred as a result of changing the way they charge for their brokerage services. For example, if not excepted under the proposed rule, these broker-dealers would be required to prepare, submit and update adviser registration statements, 125 and to prepare and distribute client disclosures under Part II of Form ADV. 126 These broker-dealers would also be required to modify their compliance programs to address the Advisers Act and its requirements, 127 and to establish codes of ethics required under the Act's rules. 128 Because the costs of satisfying these and other requirements under the Advisers Act vary from firm to firm depending on its size and complexity, they are difficult to quantify.

125 Advisers registered with the Commission must prepare Part 1A of Form ADV and file it with the SEC on the IARD system. Since Part 1A requires advisers to answer basic questions about their businesses, and can be completed using information readily available to the registrant, costs to prepare the form are typically small, but for some larger registrants with complex operations and many employees and affiliates, the costs may be somewhat higher, and may include professional fees. Adviser registrants submitting their Form ADVs through the IARD are required to pay filing fees to the operator of the system which range from $150 to $1,100 initially and $100 to $550 annually

costs to prepare the form are typically small, but for some larger registrants with complex operations and many employees and affiliates, the costs may be somewhat higher, and may include professional fees. Adviser registrants submitting their Form ADVs through the IARD are required to pay filing fees to the operator of the system which range from $150 to $1,100 initially and $100 to $550 annually. See Designation of NASD Regulation, Inc. to Establish the Investment Adviser Registration Depository; Approval of IARD Fees, Investment Advisers Act Release No. 1888 (July 28, 2000) [65 FR 47807 (Aug. 3, 2000)].

126 Rule 204-3 [17 CFR 275.204-3].

127 Rule 206(4)-7 [17 CFR 275.206(4)-7].

128 Rule 204A-1 [17 CFR 275.204A-1].

ii. Investor Benefits

By eliminating regulatory disincentives to re-pricing of brokerage services, proposed rule 202(a)(11)-1 is expected to yield benefits for individual investors as a result of such re-pricing. Under the fee-based programs discussed above, a broker-dealer's compensation does not depend on the number of transactions or the size of mark-ups or mark-downs charged, thus reducing incentives for the broker-dealer to churn accounts, recommend unsuitable securities, or engage in high-pressure sales tactics. As such, these programs may better align the interests of broker-dealers and their customers. The rule would also benefit customers by enabling them to choose from among these new programs and other traditional brokerage services to select the program best for them. While it is difficult to quantify the value of these benefits, we believe they are substantial.

b. Costs

its, we believe they are substantial.

b. Costs

While we believe the benefits of proposed rule 202(a)(11)-1(a) are substantial, we believe the incremental costs associated with this provision of the proposed rule are small. The only incremental cost associated with this provision of the rule would be the cost of adding a disclosure statement to the affected account agreements and advertisements. As discussed in our Paperwork Reduction Act analysis, we believe this cost is insignificant. 129 We believe the proposed disclosure is necessary to prevent investor confusion. Furthermore, the cost of the disclosure would be incurred only by those broker-dealers electing to rely on the rule.

129 See Section VII.A. of this Release, infra. Broker-dealers would be required to include prominent statements that the account in question is a brokerage account, not an advisory account, and that, as a consequence, the customer's rights and the firm's duties and obligations to the customer, including the scope of the firm's fiduciary obligations, may differ. The firm would also be required to direct the customers to a person who can discuss with the customers the differences between the accounts.

Because it would only operate to except from the Advisers Act certain brokerage accounts, proposed rule 202(a)(11)-1(a) would not increase the regulatory burden borne by investment advisers. Some commenters responding to our Proposing Release argued the proposed exception would grant broker-dealers—who give investment advice without complying with the Advisers Act—a competitive advantage over investment advisers subject to the Advisers Act, thereby indirectly imposing costs on investment advisers

le 202(a)(11)-1(a) would not increase the regulatory burden borne by investment advisers. Some commenters responding to our Proposing Release argued the proposed exception would grant broker-dealers—who give investment advice without complying with the Advisers Act—a competitive advantage over investment advisers subject to the Advisers Act, thereby indirectly imposing costs on investment advisers. However, because the proposed rule would be restricted to investment advice which is solely incidental to brokerage services (and broker-dealers have long been subject to this solely incidental standard under section 202(a)(11)(C) of the Advisers Act), the rule would not establish new opportunities for broker-dealers to compete with advisers on the nature of their investment advice. Also, in providing this advice, broker-dealers would remain subject to their own costs of regulation under the Exchange Act. 130

130 See supra note 58 and accompanying text.

Some commenters responding to the Proposing Release additionally asserted the proposed exception would impose 131 Just as we do not believe that the congressional exception for certain broker-dealers from the Advisers Act harms investors, so too we do not believe that proposed rule 202(a)(11)-1(a) would result in investor harm. In addition, we have enhanced the proposed rule's disclosure requirements, and these would, at a minimum, put broker-dealer customers on inquiry as to the nature of the account. 132

131 As we discuss supra in notes 52—54 and accompanying text, broker-dealers are subject to their own obligations to disclose conflicts, and are subject to an extensive investor protection regime.

132 See supra note 129.

2. Discretionary Accounts

a. Benefits

isclose conflicts, and are subject to an extensive investor protection regime.

132 See supra note 129.

2. Discretionary Accounts

a. Benefits

Under proposed rule 202(a)(11)-1(b), broker-dealers providing discretionary investment advice would not be able to rely on the broker-dealer exception under the Advisers Act, and would be subject to the Act with respect to their discretionary accounts. Proposed rule 202(a)(11)-1(b) would benefit investors to the extent they are confused as to the nature of discretionary brokerage. As previously noted, in many respects discretionary brokerage relationships are difficult to distinguish from investment advisory relationships. 133 By definitively treating such accounts as advisory accounts, the proposed rule would promote understanding by investors of the nature of the service they are receiving. More importantly, we believe that it may ensure that accounts that have the supervisory or managerial character we have identified as warranting Advisers Act coverage are, in fact, covered.

133 Indeed, it is in part this potential for confusion that counsels us to exclude discretionary accounts from the exception in proposed rule 202(a)(11)-1(a), above.

b. Costs

Proposed rule 202(a)(11)-1(b) would entail costs for broker-dealers that maintain discretionary accounts, in the form of Advisers Act compliance costs for these accounts. These costs would be lower for dually-registered broker-dealers that have already established a compliance infrastructure under the Advisers Act (or that could shift affected accounts to an affiliated investment adviser), and would be higher for broker-dealers that would have to become newly-registered under the Advisers Act. Because these costs of compliance and registration would vary from firm to firm depending on its size and complexity, these costs are difficult to quantify.

For broker-dealers already dually-registered as investment advisers, the proposed rule would result in costs to treat discretionary accounts as advisory accounts

oker-dealers that would have to become newly-registered under the Advisers Act. Because these costs of compliance and registration would vary from firm to firm depending on its size and complexity, these costs are difficult to quantify.

For broker-dealers already dually-registered as investment advisers, the proposed rule would result in costs to treat discretionary accounts as advisory accounts. Based on staff experience, we believe that many dual registrants currently treat discretionary accounts as advisory accounts, and would be in compliance with the proposed rule without further action. To the extent that other dually-registered broker-dealers would be required to treat discretionary accounts as advisory accounts, they would incur costs associated with subjecting such accounts to the Advisers Act and its requirements. 134 For example, under the Advisers Act, they would be required to deliver brochures and make other required disclosures with respect to these accounts, and observe principal trading restrictions. Nonetheless, we believe these costs would be mitigated because as advisers, these broker-dealers already have systems in place to satisfy such requirements, and the costs are account-specific. Dually-registered broker dealers converting discretionary accounts may also incur additional documentation costs to execute new account agreements with affected clients.

134 As discussed below, there are approximately 900 dually-registered broker-dealers that engage in types of broker-dealer activities that might involve discretionary accounts. We do not collect data from broker-dealers on whether or how they maintain discretionary accounts for their customers, so we cannot estimate how many of these dual registrants would be affected by the proposed rule. The staff interpretations on which broker-dealers have relied to hold discretionary accounts not subject to the Advisers Act apply only to broker-dealers who hold a limited number of such accounts

llect data from broker-dealers on whether or how they maintain discretionary accounts for their customers, so we cannot estimate how many of these dual registrants would be affected by the proposed rule. The staff interpretations on which broker-dealers have relied to hold discretionary accounts not subject to the Advisers Act apply only to broker-dealers who hold a limited number of such accounts. To the extent that broker-dealers have limited their acceptance of discretionary accounts accordingly, there would be a correspondingly limited impact on broker-dealers if we adopt the proposed rule.

In many instances, broker-dealers that are not dually registered are affiliated with investment advisers. Based on staff experience, we believe that many of these broker-dealers have refrained from engaging in the discretionary brokerage business, and have instead looked to their advisory affiliates to provide portfolio management to investors seeking this kind of service. Other broker-dealers that have not refrained from accepting discretionary brokerage services could implement the requirements of the proposed rule by shifting these customers to their advisory affiliates. In so doing, they would incur the lesser compliance costs of the types discussed above for dual registrants, rather than the greater costs discussed below for new registrants.

For broker-dealers whose maintenance of discretionary accounts would require them to register as investment advisers for the first time, the proposed rule would result in costs associated with registration under the Advisers Act and compliance with the Act's requirements. Although we acknowledge that the costs of registration and compliance under the Advisers Act are significant, 135 we believe that such costs would be mitigated by the fact that these firms could build upon the infrastructure they already have in place as broker-dealers, much of which overlaps with Advisers Act requirements

stration under the Advisers Act and compliance with the Act's requirements. Although we acknowledge that the costs of registration and compliance under the Advisers Act are significant, 135 we believe that such costs would be mitigated by the fact that these firms could build upon the infrastructure they already have in place as broker-dealers, much of which overlaps with Advisers Act requirements. For example, these broker-dealers are already subject to rules requiring designation of a chief compliance officer, establishment and maintenance of written compliance procedures, maintenance

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