Certain Broker-Dealers Deemed Not To Be Investment Advisers
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Federal Register › Vol. 64 › 64 FR 61226
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 275 and 279
[Release Nos. 34-42099; IA-1845; 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.
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SUMMARY: Broker-dealers have begun offering their customers full
service brokerage (including advice) for an asset-based fee instead of
traditional commissions, mark-ups, and mark-downs. Some full service
broker-dealers have also begun offering electronic trading for reduced
brokerage commissions. The Commission is publishing for comment a new
rule under the Investment Advisers Act of 1940 (Advisers Act) that
would address the application of the Advisers Act to brokers offering
these programs. The new rule would keep broker-dealers from being
subject to the Advisers Act solely as a result of re-pricing their
services.
DATES: Comments must be received on or before January 14, 2000.
ADDRESSES: Comments should be submitted in triplicate to Jonathan G.
Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street,
N.W., Washington, D.C. 20549-0609. Comments may also be submitted
electronically at the following E-mail address: [email protected].
All comment letters should refer to File No. S7-25-99; this File number
should be included on the subject line if E-mail is used. Comment
letters will be available for public inspection and copying in the
Commission's Public Reference Room, 450 Fifth Street, N.W., Washington,
D.C. 20549. Electronically submitted comment letters also will be
posted on the Commission's Internet web site (http://www.sec.gov).
tters should refer to File No. S7-25-99; this File number
should be included on the subject line if E-mail is used. Comment
letters will be available for public inspection and copying in the
Commission's Public Reference Room, 450 Fifth Street, N.W., Washington,
D.C. 20549. Electronically submitted comment letters also will be
posted on the Commission's Internet web site (http://www.sec.gov).
FOR FURTHER INFORMATION CONTACT: Cynthia M. Fornelli, Attorney Fellow,
Division of Investment Management, (202) 942-0720, or J. David Fielder,
Senior Counsel, Task Force on Investment Adviser Regulation, Division
of Investment Management, (202) 942-0530, [email protected], at
Securities and Exchange Commission, 450 Fifth Street, N.W., Washington,
D.C. 20549-0506.
SUPPLEMENTARY INFORMATION: The Commission is requesting public comment
on proposed rule 202(a)(11)-1 and a proposed amendment to the
instructions for Schedule I of Form ADV [17 CFR 279.1], both under the
Investment Advisers Act of 1940 [15 U.S.C. 80b] (``Advisers Act'' or
``Act'').
Table of Contents
Executive Summary
I. Background
II. Discussion
A. Broker-Dealers Deemed Not To Be Investment Advisers
1. Fee-Based Brokerage Programs
2. Execution-Only Brokerage Programs
3. Scope of Broker-Dealer Exception
B. Calculation of Assets under Management for Broker-Dealers
III. General Request For Comment
IV. Paperwork Reduction Act
V. Cost-Benefit Analysis
VI. Initial Regulatory Flexibility Analysis
VII. Statutory Authority
Text of Proposed Rule
Executive Summary
emed Not To Be Investment Advisers
1. Fee-Based Brokerage Programs
2. Execution-Only Brokerage Programs
3. Scope of Broker-Dealer Exception
B. Calculation of Assets under Management for Broker-Dealers
III. General Request For Comment
IV. Paperwork Reduction Act
V. Cost-Benefit Analysis
VI. Initial Regulatory Flexibility Analysis
VII. Statutory Authority
Text of Proposed Rule
Executive Summary
Broker-dealers recently have begun to give their customers the
option of paying for brokerage services in different ways. In addition
to traditional commission-based brokerage, customers can now pay for
securities transactions, related advice, and other services by paying a
fee that is a fixed dollar amount or based on a percentage of assets
held on account with the broker-dealer. Customers can also pay a
reduced commission for electronic trading without the assistance and
advice of a registered representative.
While these new programs promise to benefit broker-dealer customers
by aligning their interests more closely with those of the brokerage
firm and its registered representatives, they may also subject the
broker-dealers to regulation under the Advisers Act as well as the
Securities Exchange Act of 1934 (Exchange Act). The new programs
essentially re-price traditional full service brokerage programs but do
not fundamentally change their nature. Therefore, we are proposing to
use our authority under the Act to adopt a rule that would keep broker-
dealers from being subject to the Advisers Act when they offer these
programs.
Under the proposed rule, a broker-dealer providing investment
advice to customers, regardless of the form of its compensation, would
be excluded from the definition of investment adviser as long as: (i)
The advice is provided on a non-discretionary basis; (ii) the advice is
solely incidental to the brokerage services; and (iii) the broker-
dealer discloses to its customers that their accounts are brokerage
accounts
, a broker-dealer providing investment
advice to customers, regardless of the form of its compensation, would
be excluded from the definition of investment adviser as long as: (i)
The advice is provided on a non-discretionary basis; (ii) the advice is
solely incidental to the brokerage services; and (iii) the broker-
dealer discloses to its customers that their accounts are brokerage
accounts. The rule also would keep a broker-dealer providing advice to
customers from being subject to the Advisers Act solely because it also
offers execution-only brokerage services at reduced commission rates.
Finally, the proposed rule will clarify that broker-dealers that are
subject to the Advisers Act are subject to the Act only with respect to
advisory clients. We are also proposing to amend the instructions for
Form ADV under the Advisers Act to clarify how broker-dealers calculate
the aggregate assets under management of their advisory clients for
determining whether they must register with the Commission.
Until the Commission takes final action on the proposed rule, the
Division of Investment Management will not recommend, based on the form
of compensation received, that the Commission take any action against a
broker-dealer for failure to treat any account over which the broker-
dealer does not exercise investment discretion as subject to the Act.
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.\1\ 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.'' \2\ 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 o
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.'' \2\ 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\
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\1\ 15 U.S.C 80b-2(a)(11). For a discussion of this definition
and the scope of the Advisers Act, see Investment Advisers Act
Release No. 1092 (Oct. 8, 1987) [52 FR 38400 (Oct. 16, 1987)].
\2\ 15 U.S.C. 80b-2(a)(11)(C). A person (including a broker-
dealer) that falls within the definition of investment adviser in
Section 202(a)(11) (and is not excepted) must register with the
Commission unless one of the exemptions from registration in Section
203(b) [15 U.S.C. 80b-3(b)] is available or the person is prohibited
from registering with us by Section 203A [15 U.S.C. 80b-3A] because
they are a state-regulated adviser. See Rules Implementing
Amendments to the Investment Advisers Act of 1940, Investment
Advisers Act Release No. 1633 (May 15, 1997) [62 FR 28112 (May 22,
1997)].
\3\ Opinion of General Counsel Relating to Section 202(a)(11)(C)
of the Investment Advisers Act of 1940, Investment Advisers Act
Release No. 2 (Oct. 28, 1940) [11 FR 10996 (Oct. 28, 1940)]
(``Release No. 2'').
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stment adviser, including disclosure about the firm's
conflicts of interest, other business activities and affiliations,
disciplinary history and, in some cases, financial condition. Rule
206(4)-4 [17 CFR 275.206(4)-4]. Advisory clients' accounts also have
restrictions on effecting principal trades. 15 U.S.C. 80b-6(3).
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Recently, several full service brokerage firms have introduced or
announced new types of brokerage programs that raise questions as to
whether they are receiving special compensation and, as a result,
whether they continue to be eligible for the broker-dealer exception to
the Advisers Act. In the case of broker-dealers
already registered under the Act, these programs raise the question of
whether customers selecting these new programs must be treated as
advisory clients. For convenience, we will refer to these programs as
``fee-based programs.'' \7\
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\7\ For ease of discussion, we assume in the discussion below
that broker-dealers offering fee-based programs are currently
registered with us under the Advisers Act as a result of advisory
activities unrelated to these programs. For broker-dealers that are
not currently registered with us under the Advisers Act, fee-based
programs present a first question of whether they are subject to the
Act and, if so, whether they must register with us as an adviser.
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us under the Advisers Act as a result of advisory
activities unrelated to these programs. For broker-dealers that are
not currently registered with us under the Advisers Act, fee-based
programs present a first question of whether they are subject to the
Act and, if so, whether they must register with us as an adviser.
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Fee-based programs offer customers a package of brokerage
services--including execution, investment advice, custodial and
recordkeeping services--for a fixed fee or a fee based on the amount of
assets on account with the broker-dealer. In some programs, broker-
dealers also assess a fixed charge for each transaction.\8\ These fee-
based programs benefit customers by better aligning their interests
with those of their broker-dealers, and thus are responsive to the best
practices suggested in the Report of the Committee on Compensation
Practices (``Tully Report'').\9\ Under these programs, broker-dealers''
and their registered representatives' compensation no longer depends on
the number of transactions or the size of mark-ups or mark-downs
charged, thus reducing incentives for registered representatives to
churn accounts, recommend unsuitable securities, or engage in high-
pressure sales tactics. The Commission welcomes the introduction of
these programs, which may reduce substantially conflicts between
broker-dealers and their customers.
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s or mark-downs
charged, thus reducing incentives for registered representatives to
churn accounts, recommend unsuitable securities, or engage in high-
pressure sales tactics. The Commission welcomes the introduction of
these programs, which may reduce substantially conflicts between
broker-dealers and their customers.
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\8\ ``Merrill Adapting to New Breed of Investors,'' The Deseret
News (Salt Lake City, UT), July 18, 1999; ``A New Order for
Brokers,'' Los Angeles Times, July 4, 1999; ``Prudential Rolls Out
Fee-Plus Pricing Alternative,'' Registered Representative, July
1999; ``Charley's Web: Drawing Rivals into the Internet, Schwab
Takes its Biggest Risk,'' Investment Dealers Digest, June 21, 1999;
``Online Trading Forces Brokerages to Change,'' Star Tribune
(Minneapolis, MN), June 7, 1999.
\9\ The Tully Report was prepared by a committee formed in 1994
at the request of Chairman Arthur Levitt to identify the brokerage
industry's ``best practices.'' Report of the Committee on
Compensation Practices, Apr. 10, 1995. See also ``You Should Get
What You Pay for--and Vice Versa,'' Los Angeles Times, July 4, 1999;
``No More Portfolio-Churning Broker-Dealers,'' The Washington Post,
June 7, 1999.
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Some full service brokerage firms are also ``unbundling'' brokerage
services, giving customers the option of purchasing execution-only
services at a reduced commission rate.\10\ These execution-only
programs often give customers the ability to trade securities over the
Internet without the assistance of a registered representative. These
programs offer customers who do not want or need investment advice the
ability to trade securities at a lower commission rate.\11\
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educed commission rate.\10\ These execution-only
programs often give customers the ability to trade securities over the
Internet without the assistance of a registered representative. These
programs offer customers who do not want or need investment advice the
ability to trade securities at a lower commission rate.\11\
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\10\ ``Merrill Adapting to New Breed of Investors,'' The Deseret
News (Salt Lake City, UT), July 18, 1999.
\11\ Some discount brokers are now providing some advice to
their brokerage customers. ``Charley's Web: Drawing Rivals into the
Internet, Schwab Takes its Biggest Risk,'' Investment Dealers
Digest, June 21, 1999. The distinctions between full service
brokerage firms and discount brokerage firms are thus becoming
blurred.
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Both types of programs may result in the loss of the broker-dealer
exception to the Advisers Act. Fee-based compensation may constitute
special compensation under the Act because it involves the receipt by a
broker of compensation other than traditional brokerage
commissions.\12\ In addition, the introduction of execution-only
services at a lower commission rate may trigger application of the Act
to the full service accounts for which the broker provides some
investment advice. This is because the difference between full service
and execution-only commission rates represents a clearly definable
portion of a brokerage commission that is attributable, at least in
part, to investment advice. We have viewed such a two-tiered fee
structure as an indication of ``special compensation'' under the
Advisers Act.\13\
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the difference between full service
and execution-only commission rates represents a clearly definable
portion of a brokerage commission that is attributable, at least in
part, to investment advice. We have viewed such a two-tiered fee
structure as an indication of ``special compensation'' under the
Advisers Act.\13\
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\12\ See Committee on Banking and Currency, Investment Company
Act of 1940 and Investment Advisers Act of 1940, Report No. 1775,
76th Cong., 3d Sess. 22 (June 6, 1940) (section 202(a)(11)(C)
applies to broker-dealers ``insofar as their advice is merely
incidental to brokerage transactions for which they receive
brokerage commissions''). See also Financial Planners: Report of the
Staff of the United States Securities and Exchange Commission to the
House Committee on Energy and Commerce's Subcommittee on
Telecommunications and Finance, February 1988 (Appendix B)
(``[Special compensation] has been interpreted to exclude ordinary
brokerage commissions * * * unless a `clearly definable' part of the
commission is for investment advice.'')
Five years ago we adopted rules for broker-sponsored wrap fee
programs based on our conclusion that wrap fees constitute special
compensation. Disclosure by Investment Advisers Regarding Wrap Fee
Programs, Investment Advisers Act Release No. 1401 (Jan. 13, 1994)
at n.2 (proposing amendments to Form ADV) [59 FR 3033 (Jan. 20,
1994)]; Investment Advisers Act Release. No. 1411 (Apr. 19, 1994)
(adopting amendments to Form ADV) [59 FR 21657 (Apr. 26, 1994)]. See
also National Regulatory Services, SEC No-Action Letter (Dec. 2,
1992). The compensation in the new, fee-based programs is
indistinguishable from wrap fee compensation.
\13\ Release 626, supra at note 5. See also Release No. 2, supra
at note 3; Robert S. Strevell, SEC No-Action Letter (Apr
Release. No. 1411 (Apr. 19, 1994)
(adopting amendments to Form ADV) [59 FR 21657 (Apr. 26, 1994)]. See
also National Regulatory Services, SEC No-Action Letter (Dec. 2,
1992). The compensation in the new, fee-based programs is
indistinguishable from wrap fee compensation.
\13\ Release 626, supra at note 5. See also Release No. 2, supra
at note 3; Robert S. Strevell, SEC No-Action Letter (Apr. 29, 1985)
(``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.'')
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These new programs are not, however, fundamentally different from
traditional brokerage programs not subject to the Advisers Act. Fee-
based brokerage programs offer the same package of services as
traditional full-service broker-dealer programs. Execution-only
programs do not offer any advisory service, but merely make visible
that which has always been apparent--a portion of commissions charged
by full service broker-dealers compensated the broker-dealer for
advisory services. The re-pricing of traditional brokerage services in
the fee-based programs has regulatory implications only because the
broker-dealer exception is limited to broker-dealers not receiving
special compensation.
As discussed above, we believe that broker-dealers offering fee-
based programs may be receiving ``special compensation'' under the
Advisers Act. We do not believe, however, that Congress intended these
programs, which are not substantially different from traditional
brokerage arrangements, to be subject to the Act. While in 1940 the
form of compensation a broker-dealer received may have been a reliable
distinction between brokerage and advisory services, development of the
new brokerage programs suggest strongly that it is no longer
. We do not believe, however, that Congress intended these
programs, which are not substantially different from traditional
brokerage arrangements, to be subject to the Act. While in 1940 the
form of compensation a broker-dealer received may have been a reliable
distinction between brokerage and advisory services, development of the
new brokerage programs suggest strongly that it is no longer. Moreover,
we are concerned that, as a result of these new programs, most
brokerage arrangements by full service broker-dealers may be subject to
regulation under both the Advisers Act and the Exchange Act, a result
Congress could not have intended. We are therefore proposing a new
rule, described below, that would deem a broker-dealer not to be an
adviser solely as a result of receiving special compensation, provided
certain conditions are met. The proposed exception would be limited to
circumstances where the Commission believes that Congress did not
intend to apply the Advisers Act.
II. Discussion
A. Broker-Dealers Deemed Not To Be Investment Advisers
The Commission is proposing new rule 202(a)(11)-1 under the
Advisers Act. The rule is designed to avoid application of the Advisers
Act to broker-dealers solely because they re-price their full-service
brokerage or provide execution-only services in addition to full
service brokerage. The rule would also codify our long-standing view of
how the Act applies to broker-dealers that are registered advisers.
ion is proposing new rule 202(a)(11)-1 under the
Advisers Act. The rule is designed to avoid application of the Advisers
Act to broker-dealers solely because they re-price their full-service
brokerage or provide execution-only services in addition to full
service brokerage. The rule would also codify our long-standing view of
how the Act applies to broker-dealers that are registered advisers.
1. Fee-Based Brokerage Programs
Under the proposed rule, a broker-dealer providing investment
advice to its brokerage customers would not be required to treat those
customers as advisory clients solely because of the form of the broker-
dealer's compensation. The proposed rule would be available to broker-
dealers registered under the Exchange Act that satisfy three
conditions: (i) The broker-dealer must not exercise investment
discretion over the account from which it receives special
compensation; (ii) any investment advice is incidental to the brokerage
service provided to each account; and (iii) advertisements for and
contracts or agreements governing the account must contain a prominent
statement that it is a brokerage account.\14\
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\14\ Proposed rule 202(a)(11)-1(a)(1)-(3).
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Under the rule, the nature of the services provided, rather than
the form the broker-dealer's compensation takes, would be the primary
feature distinguishing an advisory account from a brokerage account
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\14\ Proposed rule 202(a)(11)-1(a)(1)-(3).
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Under the rule, the nature of the services provided, rather than
the form the broker-dealer's compensation takes, would be the primary
feature distinguishing an advisory account from a brokerage account.
Discretionary accounts that are charged an asset-based 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.\15\ Under the
statute, however, discretionary accounts from which a broker-dealer
does not receive special compensation, e.g., accounts that pay
commissions, would still be treated as brokerage accounts not subject
to the Act. In this respect, a regulatory distinction would continue to
be drawn based solely on the pricing of an advisory service. We request
comment on whether this remains an appropriate distinction. Should all
discretionary accounts of broker-dealers be treated as advisory
accounts? \16\
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\15\ See Release 626, supra at note 5.
\16\ In Release 626, supra at note 5, we stated that broker-
dealer 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 indicated that we were considering taking action
that would make the broker-dealer exception not available to broker-
dealers that exercised discretionary authority. We also noted in
Release 626 the staff's position that broker-dealers whose business
consists almost exclusively of managing accounts on a discretionary
basis are not providing advice solely on an incidental basis, and
thus are subject to the Advisers Act
sidering taking action
that would make the broker-dealer exception not available to broker-
dealers that exercised discretionary authority. We also noted in
Release 626 the staff's position that broker-dealers whose business
consists almost exclusively of managing accounts on a discretionary
basis are not providing advice solely on an incidental basis, and
thus are subject to the Advisers Act.
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The proposed rule would include the requirement, taken from the
broker-dealer exception, that the advisory services provided the
account be incidental to the brokerage services provided.\17\ The rule
would clarify that the advice the broker-dealer provides must be
incidental to brokerage services provided by the broker-dealer to each
account rather than the overall operations of the broker-dealer.
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\17\ Proposed rule 202(a)(11)-1(a)(2).
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Finally, the proposed rule would require that all advertisements
for the accounts and all agreements and contracts governing the
operation of the accounts contain a prominent statement that the
accounts are brokerage accounts.\18\ We have observed that some broker-
dealers offering these new accounts have heavily marketed them based on
the advisory services provided rather than the execution services,
which raises troubling questions as to whether the advisory services
are not (or will be perceived by investors not to be) incidental to the
brokerage services. We have, however, never viewed the broker-dealer
exception as precluding a broker-dealer from marketing itself as
providing some amount of advisory services.\19\ Comment is requested as
to whether, instead of the proposed disclosure, we should preclude
brokers from relying on the rule if they market these accounts in such
a way as to suggest they are advisory accounts
the
brokerage services. We have, however, never viewed the broker-dealer
exception as precluding a broker-dealer from marketing itself as
providing some amount of advisory services.\19\ Comment is requested as
to whether, instead of the proposed disclosure, we should preclude
brokers from relying on the rule if they market these accounts in such
a way as to suggest they are advisory accounts.
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\18\ Proposed rule 202(a)(11)-1(a)(3). An advertisement would
include any notice, circular, letter or other written communication
addressed to more than one person, or any notice or other
announcement in any publication or by radio or television. See Rule
206(4)-1(b) [17 CFR 275.206(4)-1(b)] (defining the term
``advertisement'').
\19\ See Elmer D. Robinson, SEC No-Action Letter (Jan. 6, 1986);
Nathan & Lewis, SEC No-Action Letter (Apr. 4, 1988). However, a
broker-dealer that employs terms such as ``financial planner''
merely as a device to induce the sale of securities might violate
the antifraud provisions of the Securities Act of 1933 and the
Exchange Act. Cf. In re Haight & Co., Inc., Securities Exchange Act
Release No. 9082 (Feb. 19, 1971) (Broker-dealer defrauded its
customers in the offer and sale of securities by holding itself out
as a financial planner that would give comprehensive and expert
planning advice and choose the best investments for its clients from
all available securities, when in fact it was not an expert in
planning and made its decisions based on the receipt of commissions
and upon its inventory of securities.)
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lding itself out
as a financial planner that would give comprehensive and expert
planning advice and choose the best investments for its clients from
all available securities, when in fact it was not an expert in
planning and made its decisions based on the receipt of commissions
and upon its inventory of securities.)
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Under the proposed rule, broker-dealer sponsors of wrap fee
programs would continue to treat wrap fee accounts as advisory
accounts.\20\ Wrap fee program sponsors that also provide portfolio
management services typically have discretionary authority over the
accounts, and thus could not use the rule. In many cases, sponsors of
wrap fee programs execute transactions for wrap accounts and provide
some non-discretionary advisory services such as asset allocation or
selection of portfolio managers. The sponsors do not themselves have
discretionary authority, which is delegated to an advisory firm that
receives a portion of the wrap fee. In these cases, the non-
discretionary advisory services provided by the sponsor could not be
viewed as incidental to the brokerage services.\21\
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\20\ Sponsors must, therefore, continue to deliver to wrap fee
clients a wrap fee brochure required by Rule 204-3(f) under the
Advisers Act [17 CFR 275.204-3(f)]. See also Schedule H of Form ADV
[17 CFR 279.1] (prescribing contents of a wrap fee brochure).
\21\ The brokerage transactions executed by the sponsor are
initiated by the third-party portfolio manager, and not the sponsor.
See generally, National Regulatory Services, SEC No-Action Letter
(Dec
clients a wrap fee brochure required by Rule 204-3(f) under the
Advisers Act [17 CFR 275.204-3(f)]. See also Schedule H of Form ADV
[17 CFR 279.1] (prescribing contents of a wrap fee brochure).
\21\ The brokerage transactions executed by the sponsor are
initiated by the third-party portfolio manager, and not the sponsor.
See generally, National Regulatory Services, SEC No-Action Letter
(Dec. 2, 1992) (wrap fee program is not solely incidental to the
sponsor's business as a broker-dealer); ``Mutual Fund Blues? Try a
`Wrap,' '' Business Week, July 12, 1999 (``[B]rokerage firms also
offer annual asset-based fees as an alternative to charging
commissions on each trade [but] the accounts don't offer the same
services [as wrap accounts].'')
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2. Execution-Only Brokerage Programs
Proposed rule 202(a)(11)-1 would also keep a full service broker-
dealer from being subject to the Act solely because it also offers
execution-only brokerage.\22\ Conversely, a discount broker would not
be subject to the Act solely because it introduces a full service
brokerage program. Under the rule, a broker-dealer would 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. Thus, a broker-dealer would be able to offer both
full-service and execution-only brokerage without losing the broker-
dealer exception. This provision would make a broker-dealer's
eligibility for the broker-dealer exception with respect to an account
turn on the characteristics of that account and not others.
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\22\ Proposed rule 202(a)(11)-1(b).
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ing the broker-
dealer exception. This provision would make a broker-dealer's
eligibility for the broker-dealer exception with respect to an account
turn on the characteristics of that account and not others.
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\22\ Proposed rule 202(a)(11)-1(b).
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3. Scope of Broker-Dealer Exception
As discussed above, a broker-dealer registered under both the
Exchange Act (as a broker-dealer) and the Advisers Act (as an adviser)
need not treat all of its customers as advisory clients. We have viewed
the Advisers Act as applying only to those customers to whom the
broker-dealer provides advice that is not incidental to brokerage
services or for which the firm receives special compensation.\23\ We
have included a provision in the proposed rule codifying this view.\24\
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\23\ Release No. 626, supra at note 5.
\24\ Proposed rule 202(a)(11)-1(c).
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B. Calculation of Assets Under Management for Broker-Dealers
Generally, only investment advisers with at least $25 million of
assets under management must register with the
Commission.\25\ Advisers with fewer assets under management generally
must register with one or more state securities authorities.\26\ The
staff has taken the position that broker-dealers may include in their
calculation of assets under management the value of brokerage accounts
that receive continuous and regular supervisory or management
services.\27\ We are proposing to codify this position by amending the
instructions to Schedule I of Form ADV, but limiting it to accounts
over which broker-dealers exercise investment discretion.\28\
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f assets under management the value of brokerage accounts
that receive continuous and regular supervisory or management
services.\27\ We are proposing to codify this position by amending the
instructions to Schedule I of Form ADV, but limiting it to accounts
over which broker-dealers exercise investment discretion.\28\
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\25\ 15 U.S.C. 80b-3A (prohibiting advisers without assets under
management of $25 million or more or that do not advise a registered
investment company from registering with the Commission). The
Commission has adopted a rule that exempts certain types of advisers
from this prohibition. 17 CFR 275.203A-2.
\26\ Id.
\27\ See http://www.sec.gov/rules/othern/advfaq.htm#asst>,
``Assets Under Management,'' Question No. 5.
\28\ Broker-dealers that are also registered with us as
investment advisers may, in certain circumstances, be requested
during the course of investment adviser inspections by Commission
staff, to provide certain information and records related to their
brokerage clients over whose accounts they exercise investment
discretion. For example, such information and records may be
necessary for an evaluation of the reported amount of assets under
management that receive continuous and regular supervisory or
management services.
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III. General Request for Comment
ed to their
brokerage clients over whose accounts they exercise investment
discretion. For example, such information and records may be
necessary for an evaluation of the reported amount of assets under
management that receive continuous and regular supervisory or
management services.
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III. General Request for Comment
Any interested persons wishing to submit written comments on the
proposed rule that is the subject of this release, or submit comments
on other matters that might have an effect on the proposals described
above, are requested to do so. Commenters suggesting alternative
approaches are encouraged to submit proposed rule text.
For purposes of the Small Business Regulatory Enforcement Fairness
Act of 1996, the Commission also is requesting information regarding
the potential impact of the proposed rule on the economy on an annual
basis. Commenters should provide empirical data to support their views.
IV. Paperwork Reduction Act
Certain provisions of proposed Rule 202(a)(11)-1 contain a
``collection of information'' within the meaning of the Paperwork
Reduction Act of 1995 (44 U.S.C. 3501 to 3520), and the Commission has
submitted it to the Office of Management and Budget in accordance with
44 U.S.C. 3507(d) and 5 CFR 1320.11. The title for the collection of
information is ``Certain Broker-Dealers Deemed Not To Be Investment
Advisers.'' An agency may not sponsor, conduct, or require response to
an information collection unless a currently valid OMB control number
is displayed.
Broker-dealers taking advantage of the proposed rule would need to
maintain certain records that establish their eligibility to do so, but
rules under the Exchange Act already require the maintenance of those
records
Not To Be Investment
Advisers.'' An agency may not sponsor, conduct, or require response to
an information collection unless a currently valid OMB control number
is displayed.
Broker-dealers taking advantage of the proposed rule would need to
maintain certain records that establish their eligibility to do so, but
rules under the Exchange Act already require the maintenance of those
records. Specifically, broker-dealers are currently required to
maintain all ``evidence of the granting of discretionary authority
given in any respect of any account'' \29\ and all ``written agreements
* * * with respect to any account.'' \30\ Therefore, the proposed rule
will not increase the recordkeeping burden for any broker-dealer.
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\29\ 17 CFR 240.17a-4(b)(6). Proposed rule 202(a)(11)-1(a)(1)
limits its application to accounts that a broker-dealer does not
exercise investment discretion over.
\30\ 17 CFR 240.17a-4(b)(7). Proposed rule 202(a)(11)-1(a)(3)
requires a prominent statement be made in agreements governing the
accounts to which the rule applies.
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For an account to which the proposed rule applies, advertisements
\31\ and contracts or agreements must include a prominent statement
that the account is a brokerage account.\32\ This information is
necessary to prevent customers and prospective customers from
mistakenly believing that the account is an advisory account subject to
the Advisers Act and will be used to assist clients in making an
informed decision on whether to establish an account. We believe that
the burden to comply with this provision of the rule is insignificant.
In preparing model contracts and advertisements, for example,
compliance officials would be required to verify that the appropriate
disclosure is made
unt is an advisory account subject to
the Advisers Act and will be used to assist clients in making an
informed decision on whether to establish an account. We believe that
the burden to comply with this provision of the rule is insignificant.
In preparing model contracts and advertisements, for example,
compliance officials would be required to verify that the appropriate
disclosure is made. For purposes of the Paperwork Reduction Act, the
average annual burden for ensuring compliance is 5 minutes per broker-
dealer taking advantage of the proposed rule. If all of the
approximately 8,500 broker-dealers registered with us took advantage of
the rule, the total estimated annual burden would be 706 hours (.083
hours x 8,500 brokers). At an assumed $120 per hour those 706 hours
would cost $84,720. We request comment on these figures.
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\31\ Broker-dealers already are required to maintain records
regarding their advertisements under existing self-regulatory
organizations' rules.
\32\ The Commission estimates that the current annual burden for
the approximately 8,500 broker-dealers registered with us related to
the maintenance of these, and other records required by the
Commission is approximately 2.1 million hours. This is the current
burden estimate for Rule 17a-4. It includes the estimated burden
from complying with Rule 17a-4's requirements to maintain certain
records unrelated to this rule, such as customer communications,
order tickets, and transaction confirmations.
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red by the
Commission is approximately 2.1 million hours. This is the current
burden estimate for Rule 17a-4. It includes the estimated burden
from complying with Rule 17a-4's requirements to maintain certain
records unrelated to this rule, such as customer communications,
order tickets, and transaction confirmations.
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The collection of information requirements under the proposed rule
are mandatory. In general, the information collected pursuant to the
proposed rule would be held by the broker-dealers. The Commission,
self-regulatory organizations, and other securities regulatory
authorities would only gain possession of the information upon request.
Any information received by the Commission related to the proposed rule
would be kept confidential, subject to the provisions of the Freedom of
Information Act, 5 U.S.C. 552.
Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits
comments to (i) evaluate whether the proposed collection of information
is necessary for the proper performance of the functions of the agency,
including whether the information will have practical utility; (ii)
evaluate the accuracy of the agency's estimate of the burden of the
proposed collection of information; (iii) enhance the quality, utility,
and clarity of the information to be collected; and (iv) minimize the
burden of the collections of information on those who are to respond,
including through the use of automated collection techniques or other
forms of information technology.
Persons desiring to submit comments on the collection of
information requirements should direct them to the Office of Management
and Budget, Attention: Desk Officer for the Securities and Exchange
Commission, Office of Information and Regulatory Affairs, Washington,
D.C. 20503, and also should send a copy of their comments to Jonathan
G. Katz, Secretary, Securities and Exchange Commission, 450 5th Street,
N.W., Stop 6-9, Washington, D.C
lection of
information requirements should direct them to the Office of Management
and Budget, Attention: Desk Officer for the Securities and Exchange
Commission, Office of Information and Regulatory Affairs, Washington,
D.C. 20503, and also should send a copy of their comments to Jonathan
G. Katz, Secretary, Securities and Exchange Commission, 450 5th Street,
N.W., Stop 6-9, Washington, D.C. 20549 with reference to File No. 270-
471. OMB is required to make a decision concerning the collection of
information requirements between 30 and 60 days after publication. A
comment to OMB is best assured of having its full effect if OMB
receives it within 30 days of publication.
V. Cost-Benefit Analysis
The proposed rule would keep broker-dealers from being subject to
the Advisers Act solely as a result of re-pricing their full-service
brokerage services. Proposed rule 202(a)(11)-1 would have no effect on
the regulatory burden borne by investment advisers because it only
operates to exempt from the Advisers Act certain brokerage accounts.
For broker-dealers that would otherwise be subject to the Advisers Act,
the proposed rule would reduce
their regulatory burden.\33\ Thus, the benefits to broker-dealers to
which the proposed rule would apply are substantial in terms of
avoiding an increased regulatory burden stemming from re-pricing their
brokerage services.
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\33\ Investment advisers are required, for example, to deliver
an informational brochure to clients and prospective clients, Rule
204-3 [17 CFR 275.204-3], and to make detailed disclosures about the
advisory firm and its supervised persons. Rule 206(4)-4 [17 CFR
275.206(4)-4].
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----------------------------------------
\33\ Investment advisers are required, for example, to deliver
an informational brochure to clients and prospective clients, Rule
204-3 [17 CFR 275.204-3], and to make detailed disclosures about the
advisory firm and its supervised persons. Rule 206(4)-4 [17 CFR
275.206(4)-4].
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Substantial benefits for individual investors from the repricing of
brokerage services, and therefore from the proposed rule which
eliminates unintended regulatory disincentives to that repricing, are
expected. Under the fee-based programs discussed above, a broker-
dealer's or registered representative's compensation no longer depends
on the number of transactions or the size of mark-ups or mark-downs
charged, thus reducing incentives for a registered representative to
churn accounts, recommend unsuitable securities, or engage in high-
pressure sales tactics. Thus, these programs may better align the
interests of broker-dealers and their customers.
While the benefits of the proposed rule are substantial (although
difficult to quantify), the incremental costs associated with the rule
are small. Broker-dealers taking advantage of the rule will need to
maintain certain records establishing their eligibility for the rule
(e.g., contracts or agreements governing the accounts and
advertisements related to the accounts), but rules under the Exchange
Act already require the maintenance of those records. Thus, the only
incremental cost associated with the rule is the cost of adding a
statement to those documents that the accounts are brokerage accounts.
As discussed in the Paperwork Reduction Act analysis above, we believe
this cost is insignificant.
Comment is requested on issues relating to the proposed rule's
costs and benefits. Commenters are requested to provide views and
empirical data relating to any costs and benefits associated with the
proposed rule and form amendment.
t to those documents that the accounts are brokerage accounts.
As discussed in the Paperwork Reduction Act analysis above, we believe
this cost is insignificant.
Comment is requested on issues relating to the proposed rule's
costs and benefits. Commenters are requested to provide views and
empirical data relating to any costs and benefits associated with the
proposed rule and form amendment.
VI. Initial Regulatory Flexibility Analysis
The Commission has prepared the following Initial Regulatory
Flexibility Analysis (``IRFA'') in accordance with 5 U.S.C. 603
regarding proposed rule 202(a)(11)-1.
A. Reasons for Proposed Action
Broker-dealers recently have begun to give their customers the
option of paying for securities transactions, related advice, and other
services by paying a fee that is a fixed dollar amount or based on a
percentage of assets held on account with the broker-dealer. While
these new programs promise to benefit broker-dealer customers by
aligning their interests more closely with those of the brokerage firm
and its registered representatives, they may also subject the broker-
dealers to regulation under the Advisers Act. The new programs
essentially re-price traditional full service brokerage programs but do
not fundamentally change their nature. Subjecting broker-dealers that
offer these programs to the Advisers Act would impose unnecessary
regulatory burdens on the provision of brokerage services contrary to
the intent of Congress when it passed the Advisers Act.
B. Objectives and Legal Basis
Advisers Act. The new programs
essentially re-price traditional full service brokerage programs but do
not fundamentally change their nature. Subjecting broker-dealers that
offer these programs to the Advisers Act would impose unnecessary
regulatory burdens on the provision of brokerage services contrary to
the intent of Congress when it passed the Advisers Act.
B. Objectives and Legal Basis
The proposed rule is designed to prevent application of the
Advisers Act to broker-dealers solely because they re-price their full-
service brokerage or provide execution-only services in addition to
full service brokerage. The rule would also codify certain long-
standing positions regarding application of the Advisers Act to broker-
dealers that are registered advisers. We are proposing the rule
pursuant to our authority under sections 202(a)(11)(F) \34\ and 211(a)
\35\ under the Act. Section 202(a)(11)(F) gives us authority to except,
by rule or order, from the statutory definition of ``investment
adviser'' persons not within the intent of that definition. Section
211(a) gives us authority to classify, by rule, persons and matters
within our jurisdiction and to prescribe different requirements for
different classes of persons, as necessary or appropriate to the
exercise of our authority under the Act.
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\34\ 15 U.S.C. 80b-2(a)(11)(F).
\35\ 15 U.S.C. 80b-11(a).
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C. Small Entities Subject to Rule
and to prescribe different requirements for
different classes of persons, as necessary or appropriate to the
exercise of our authority under the Act.
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\34\ 15 U.S.C. 80b-2(a)(11)(F).
\35\ 15 U.S.C. 80b-11(a).
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C. Small Entities Subject to Rule
For the purposes of the Exchange Act and the Regulatory Flexibility
Act, a broker-dealer, under Commission rules, generally is a small
entity if it had total capital (net worth plus subordinated
liabilities) of less than $500,000 on the date in the prior fiscal year
as of which its audited financial statements were prepared and it is
not affiliated with any person (other than a natural person) that is
not a small entity.\36\
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\36\ 17 CFR 240.0-10(c).
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The Commission estimates that as of December 31, 1998,
approximately 1,000 Commission-registered broker-dealers were small
entities.\37\ The Commission is not aware of any small entities that
are re-pricing their brokerage services in a manner that the proposed
rule addresses, but assumes that all of these small entities could be
affected by the proposed rule.
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\37\ This estimate is based on the information provided in Form
X-17A-5 Financial and Operational Combined Uniform Single Reports
filed pursuant to section 17 of the Exchange Act and Rule 17a-5
thereunder.
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D. Reporting, Recordkeeping, and Other Compliance Requirements
-------------------------------------------------
\37\ This estimate is based on the information provided in Form
X-17A-5 Financial and Operational Combined Uniform Single Reports
filed pursuant to section 17 of the Exchange Act and Rule 17a-5
thereunder.
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D. Reporting, Recordkeeping, and Other Compliance Requirements
The proposed rule would impose no new recordkeeping requirements,
and will not materially alter the time required for broker-dealers to
comply with the Commission's rules. The proposed rule keeps unnecessary
regulatory burdens from being imposed on broker-dealers. Broker-dealers
taking advantage of the rule are required to make certain disclosures
to customers and potential customers in advertising and contractual
materials.
E. Duplicative, Overlapping, or Conflicting Federal Rules
The Commission believes that there are no rules that duplicate,
overlap, or conflict with, the proposed rule.
F. Significant Alternatives
The Regulatory Flexibility Act directs the Commission to consider
significant alternatives that would accomplish the stated objective,
while minimizing any significant adverse impact on small entities. In
connection with the proposed rule, the Commission considered the
following alternatives: (a) The establishment of differing compliance
or reporting requirements or timetables that take into account the
resources available to small entities; (b) the clarification,
consolidation, or simplification of compliance and reporting
requirements under the rule for such small entities; (c) the use of
performance rather than design standards; and (d) an exemption from
coverage of the rule, or any part thereof, for such small entities.
The proposed rule is designed to eliminate unnecessary regulatory
burdens that otherwise might be imposed on broker-dealers. Small
entities, as well as large entities, will benefit from the proposed
rule
under the rule for such small entities; (c) the use of
performance rather than design standards; and (d) an exemption from
coverage of the rule, or any part thereof, for such small entities.
The proposed rule is designed to eliminate unnecessary regulatory
burdens that otherwise might be imposed on broker-dealers. Small
entities, as well as large entities, will benefit from the proposed
rule. It is thus inappropriate to exempt small entities from the
proposed rule. The provision of the proposed rule requiring certain
disclosures to customers and potential customers is designed to prevent
investors from being misinformed regarding the nature of the services
they are receiving. Consequently, it would be
inconsistent with the purposes of the Advisers Act to use performance
standards to specify different requirements for small entities.
The Commission believes that the proposed rule will not adversely
affect small entities because it does not impose significant, new
reporting, recordkeeping, or compliance requirements. Instead, the
proposed rule would avoid the imposition of unnecessary regulatory
burdens on the provision of brokerage services solely because broker-
dealers re-price their full-service brokerage or provide execution-only
services in addition to full service brokerage. Therefore, it is not
feasible to further clarify, consolidate or simplify the rule's
provisions for small entities.
G. Solicitation of Comments
We encourage written comments on matters discussed in this IRFA. In
particular, the Commission seeks comment on: (i) The number of small
entities that would be affected by the proposed rule; and (ii) whether
the impact of the proposed rule on small entities would be economically
significant. Commenters are asked to describe the nature of any impact
and provide empirical data supporting the extent of the impact.
VII. Statutory Authority
ussed in this IRFA. In
particular, the Commission seeks comment on: (i) The number of small
entities that would be affected by the proposed rule; and (ii) whether
the impact of the proposed rule on small entities would be economically
significant. Commenters are asked to describe the nature of any impact
and provide empirical data supporting the extent of the impact.
VII. Statutory Authority
We are proposing the rule pursuant to our authority under Sections
202(a)(11)(F) and 211(a) under the Act. Section 202(a)(11)(F) gives us
authority to except, by rule or order, from the statutory definition of
``investment adviser'' persons not within the intent of that
definition.\38\ Section 211(a) gives us authority to classify, by rule,
persons and matters within our jurisdiction and to prescribe different
requirements for different classes of persons, as necessary or
appropriate to the exercise of our authority under the Act.
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\38\ Because we are using our authority under section
202(a)(11)(F), broker-dealers relying on the rule would not be
subject to state adviser statutes. Section 203A(b)(1)(B) of the Act
(15 U.S.C. 80b-3A(b)(1)(B)) provides that ``[n]o law of any State or
political subdivision thereof requiring the registration, licensing,
or qualification as an investment adviser or supervised person of an
investment adviser shall apply to any person * * * that is not
registered under [the Advisers Act] because that person is excepted
from the definition of an investment adviser under section
202(a)(11).'' (emphasis added).
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List of Subjects in 17 CFR Parts 275 and 279
Reporting and recordkeeping requirements.
Text of Proposed Rule
For the reasons set out in the preamble, Title 17, Chapter II of
the Code of Federal Regulations is proposed to be amended as follows:
PART 275--RULES AND REGULATIONS, INVESTMENT ADVISERS ACT OF 1940
added).
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List of Subjects in 17 CFR Parts 275 and 279
Reporting and recordkeeping requirements.
Text of Proposed Rule
For the reasons set out in the preamble, Title 17, Chapter II of
the Code of Federal Regulations is proposed to be amended as follows:
PART 275--RULES AND REGULATIONS, INVESTMENT ADVISERS ACT OF 1940
1. The general authority citation for part 275 is revised to read
as follows:
Authority: 15 U.S.C. 80b-2(a)(11)(F), 80b-2(a)(17), 80b-3, 80b-
4, 80b-6(4), 80b-6a, 80b-11, unless otherwise noted.
* * * * *
2. Section 275.202(a)(11)-1 is added to read as follows:
Sec. 275.202(a)(11)-1 Certain broker-dealers deemed not to be
investment advisers.
A broker or dealer registered with the Commission under Section 15
of the Securities Exchange Act of 1934 (15 U.S.C. 78o) (the ``Exchange
Act''):
(a) Will not be deemed to be an investment adviser based solely on
its receipt of special compensation, provided that:
(1) The broker or dealer does not exercise investment discretion,
as that term is defined in Section 3(a)(35) of the Exchange Act (15
U.S.C. 78c(a)(35)), over the accounts from which it receives special
compensation;
(2) Any investment advice provided by the broker or dealer with
respect to accounts from which it receives special compensation is
solely incidental to the brokerage services provided to those accounts;
and
(3) Advertisements for, and contracts or agreements governing,
accounts for which the broker or dealer receives special compensation
include a prominent statement that the accounts are brokerage accounts;
(b) Will 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; and
ning,
accounts for which the broker or dealer receives special compensation
include a prominent statement that the accounts are brokerage accounts;
(b) Will 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; and
(c) 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 Act.
PART 279--FORMS PRESCRIBED UNDER THE INVESTMENT ADVISERS ACT OF
1940
3. The authority citation for part 279 continues to read as
follows:
Authority: The Investment Advisers Act of 1940, 15 U.S.C. 80b-1,
et seq.
4. By amending Instruction 7 in Form ADV Schedule I Instructions
(referenced in Sec. 279.1) by adding paragraph (c)(5) to read as
follows:
Note: The text of Form ADV does not and the amendment will not
appear in the Code of Federal Regulations.
Form ADV
* * * * *
Schedule I Instructions
* * * * *
Instruction 7. Determining Assets Under Management
* * * * *
(c) Continuous and Regular Supervisory or Management Services.
* * * * *
Accounts that do not receive continuous and regular supervisory or
management services:
* * * * *
(5) Brokerage accounts, unless the applicant has discretionary
authority.
* * * * *
Dated: November 4, 1999.
By the Commission.
Jonathan G. Katz,
Secretary.
[FR Doc. 99-29395 Filed 11-9-99; 8:45 am]
BILLING CODE 8010-01-P
This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.