Brokerage Firms Attempt to Clarify the Confusing Roles and Responsibilities of Their Brokers

Brokerage Firms Attempt to Clarify the Confusing Roles and Responsibilities of Their Brokers

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n April 2005, the SEC adopted a rule that exempts brokers ("registered representatives") from registering as "investment advisers" under the Investment Advisers Act of 1940, even though they are paid asset-based fees or fixed fees (in lieu of commissions) so long as their investment advice is "solely incidental" to their brokerage services and they make adequate disclosure. There is a lot of "gray" there! To complicate matters further, the new SEC rule does require a broker to register as an investment adviser when he or his brokerage firm: (1) holds himself out to the public as a financial planner or as providing financial planning services; (2) delivers to his customers a financial plan; or (3) represents to the customer that the advice is provided as part of a financial plan or financial planning services.

This confusion must be clarified because the stakes are significant. Why? Investment advisers under the Investment Advisers Act of 1940 have a fiduciary duty towards their customers. Although there has been some debate as to the roles and responsibilities of brokers, who are not investment advisers, most commentators agree that their duties are more limited.

When the SEC was considering the rule proposal, several brokerage firms filed comment letters with the SEC attempting to justify why their brokers should not be required to register as investment advisers. The comment letters are helpful, if for no other reason than to highlight how difficult it has become to differentiate between a broker and an investment adviser. Let's examine the comment letters that three major wirehouses submitted. Those wirehouses are Merrill Lynch, UBS (PaineWebber) and Citigroup Global Markets (Smith Barney).

Merrill Lynch submitted its comment letter to the SEC in February, 2005. Written by its First Vice President and Assistant General Counsel, Paul S. Gottlieb, the letter states that brokerage firms have offered "planning services" to their clients for many years, and that they "are an integral part of traditional, full service brokerage." There has been much criticism regarding the brokerage firm's giving their registered representatives titles beyond that of "stockbroker", yet, remarkably, Merrill Lynch sees no confusion in that. Mr. Gottlieb argues that brokerage firms should be permitted to use such terms as "financial adviser" and "financial consultant", because "those terms are not closely associated with investment advisory services in the same manner as terms such as 'portfolio manager', 'investment adviser' or 'investment counselor.'"

Citigroup Global Markets (Smith Barney) submitted its comment letter to the SEC in September, 2004. Written by its General Counsel for Smith Barney, Michael J. Sharp, the letter defends the firm's AssetOne fee-based brokerage account. Mr. Sharp cites to the popularity of the account - Smith Barney has over 100,000 such accounts - and claims that "the product fills a specific gap in the spectrum from traditional brokerage to managed accounts." Citigroup believes that any confusion regarding this gap filler account is cured by the following "clear disclosure" in all AssetOne materials: "AssetOne is a brokerage account and not an investment advisory account." Certain other AssetOne materials contain this disclosure: "AssetOne is not an investment advisory account and should not be treated as a substitute for one." In a true leap of faith, Mr. Sharp then claims that such "clear" disclosure "helps investors frame their understanding and expectations at the outset."

UBS' (PaineWebber's) comment letter to the SEC demonstrates the extent of the confusion. Written by UBS' Executive Vice President, James D. Price, UBS candidly states that when it acts as a brokerage firm, it does not "simply take customers' orders and execute securities transactions for them." Mr. Price details how customers "seek out advice", and how the firm "endeavor[s] to provide sound advice on this and related aspects of their financial needs." Indeed, the firm "encourages" its "Financial Advisers" to assist customers "to identify their overall financial needs and goals and to create investment strategies that are reasonably designed to pursue those goals, and then to execute against that plan." UBS also provides "ongoing advice and assistance" to its customers, which is an "integral part" of its brokerage services.

Moreover, UBS offers "basic financial planning reports" to its customers as part of its brokerage services and free of charge. Despite recognizing that "most financial reports contain some elements of investment advice", Mr. Price claims that "planning analysis and recommendations cover a variety of other topics that do not involve general or specific investment advice at all and for which investment adviser regulation is neither appropriate or required."

It is apparent that determining what is, and is not, investment advice for purposes of transforming a broker into an "investment adviser" is not easy. Happily, the SEC has pledged to study the issue further, and to provide more guidance and/or proposed rule changes within 90 days of the rule's adoption date. That time fast is approaching. That's good news for all customers of brokerage firms!