FPA Journal: In the End, Votes Count in the Broker/Adviser Donnybrook

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Duane Thompson is managing director of the Financial Planning Association's Washington, D.C., office.

In the End, Votes Count in the Broker/Advisor Donnybrook by Duane Thompson

So far there have been only eight votes cast on a controversial regulatory issue that has been debated for seven years. In the next few months, there could be hundreds cast by members of Congress. Although the votes for the so-called broker/dealer rule, which exempts fee-based brokerage programs from the Investment Advisers Act of 1940, outnumber the ones opposed 6–2, the latter are the ones that matter. In a widely reported decision by a federal appeals court on March 30, a court panel voted 2–1 to vacate the rule, stating that the agency had exceeded its authority to create a new exemption for broker/dealers. In 2005, the Securities and Exchange Commission approved the rule 5–0. Of course, the votes that really count, if the SEC or the brokerage industry pursues a legislative remedy in Congress, are the 70 votes in the House Financial Services Committee and the 20 in Senate Banking Committee. These are the likely forums where any work to amend the Advisers Act will take place. As this is being written, the SEC still has until May 14 to request a rehearing with the full appeals court to avoid going to Congress. Failing that, it has until June 28 to seek review by the U.S. Supreme Court. Either legal course of action appears risky and fraught with political consequences for the once-venerated federal agency headed by Joseph Kennedy, Jr., and future Chief Justice William O. Douglas. No matter if the appeals court rejects a rehearing, that court would then have seven days to issue a formal mandate, setting in motion the process where the SEC would have to vacate the rule and draft a new one allowing the orderly transfer of nearly one million fee-based brokerage accounts to either commission accounts or to Advisers Act jurisdiction. The SEC could also file a motion to stay the court's mandate, but that would require a showing of irreparable harm and that the appeal would have a likelihood of success on its merits.

Another SEC Black Eye None of these legal strategies appear feasible, partly because the SEC is unlikely to prevail in its appeals, and partly because of a likely concern that having already lost three times in the same circuit court and in the last year over various rulemakings, an appeal that was rejected would only add another black eye. From the outset of the court battle, the SEC's defense in FPA v. SEC was languid or anemic at best. Where it might have filed a motion challenging the Financial Planning Association's legal standing in court, it waited until its final brief to inject that argument. Where it might have argued for a different choice of forum—in a lower federal court of jurisdictionÑit failed to do so. Where the fiduciary standard for investment advisers was a central part of FPA's argument over protections for investors, and in the court's analysis, the SEC brief merely mentioned it in a footnote. The court opinion was especially strong in agreeing with FPA's arguments that the

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FPA Journal: In the End, Votes Count in the Broker/Adviser Donnybrook

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http://www.fpanet.org/journal/articles/2007_Issues/jfp0507-art2.cfm

final rule creates a dual standard for investment advice, in contradiction to clear congressional intent to protect the public from frauds and to "safeguard the honest investment adviser against the stigma of the activities of these individuals." Finally, the court looked at the plain language of the exemptions from the Advisers Act, and noted that one section exempted any broker/dealer who did not receive special compensation or provide solely incidental advice, and that the SEC's authority to create new exemptions (the provision used by the SEC to exempt fee-based programs) was intended for other persons not within the intent of the previously exempted groups. Additionally, the Court found that the legislative history during the 1940 debate of the Advisers Act did not support the SEC's contention that Congress was indeed concerned over regulatory burdens for broker/dealers. Perhaps since Congress is full of lawyers, the 1940 Congress spent an inordinate amount of time debating whether attorneys, not brokers, should be exempt at all.

An Imminent Fight Hence, a fight in Congress appears imminent. There is no question that the Financial Planning Association is outgunned on Capitol Hill. But there have been other groups who share the same concern—not only in the financial planning profession, but among consumer and state regulator associations. These have ardent supporters in Congress who will listen carefully. The $64,000 question may not be about whether the securities industry is able to reinstate the broker/dealer rule by amending the Advisers Act, but whether the broader debate over fiduciary protections for the public will generate calls for major reform beyond a simple amendment. Capitol Hill committee staff is now fully aware of the festering debate over advisory standards, and there is a growing sense, both on the Hill and a grudging admission even in some quarters of the SEC and in the brokerage industry, that a fiduciary duty for persons calling themselves financial advisors is long overdue. There is that old adage about getting what you wish for. While the FPA legal challenge was a calculated risk on its own merits, the stakes may be even higher if the securities industry opens a congressional Pandora's box that leads to true reform.

Chronology: Evolution/Devolution of the Broker/Dealer Rule Spring 1940. Congress approves Investment Advisers Act of 1940; act provides for limited industry exemptions, including brokerage firms that give advice in connection with stock sales. Summer 1999. Major wirehouses meet with SEC regarding new fee-based "brokerage" programs and exemption from Investment Advisers Act of 1940. November 4, 1999. SEC proposes additional exemption for brokerage firms in a no-action rule titled "Certain Broker/Dealers Deemed Not to Be Investment Advisers." SEC staff states it would not recommend enforcement action against broker/dealers complying with proposed rule. January 14, 2000. SEC deadline for submitting comments on the rule. December 20, 1999–July 10, 2004. SEC receives 248 comment letters regarding the proposed rule. Of this total, 96 percent are opposed, 1 percent is opposed in part, 3 percent support the rule. July 20, 2004. Lawsuit filed in federal court by FPA challenging the rulemaking on technical grounds. August 18, 2004. SEC reopens comment period on rule, citing FPA legal challenge. August 27, 2004. D.C. Circuit Court of Appeals orders delay of lawsuit, following motion for delay by SEC, which promises final action on rule by December 31. Court orders reports by SEC every 45 days. September 22, 2004. SEC deadline for submitting new comments; additional 1,500 letters received since lawsuit filed, overwhelmingly opposed. December 22, 2004. SEC adopts temporary rule to extend broker exemption through April 15, 2005, proposes modified rule. Commissioners publicly pledge final rule adoption by deadline. Reopens comment period for third

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FPA Journal: In the End, Votes Count in the Broker/Adviser Donnybrook

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http://www.fpanet.org/journal/articles/2007_Issues/jfp0507-art2.cfm

time. February 7, 2005. SEC deadline for submitting comments on amended rule; receives another 300 letters for cumulative total of 2,000. February 9, 2005. D.C. Circuit Court orders SEC and FPA to file new motions related to the lawsuit by April 29, or no more than 30 days after SEC adopts final rule, whichever comes first. March 29, 2005. SEC focus groups express confusion over the many titles used by financial services agents and are generally unaware of the different standards for consumer protection. April 6, 2005. SEC unanimously adopts the broker/dealer rule (IAA Rule 202(a)(11)-1). April 28, 2005. FPA files a petition in the United States Court of Appeals for the District of Columbia Circuit challenging the SEC's final rule exempting certain broker/dealers from the requirements of the Investment Advisers Act of 1940. FPA also seeks, with the SEC's consent, to file a motion consolidating the petition with FPA's pending petition, filed on July 20, 2004, concerning the rulemaking proceeding. December 16, 2006. SEC issues a no-action letter easing the restrictions on brokerage firms offering financial planning services and effectively allowing them to offer and deliver financial plans and similar services to customers under similar-sounding marketing terms. January 31, 2006. Implementation deadline of the broker/dealer rule goes into effect: brokerage firms can no longer hold out as a financial planner or offer financial planning services, or deliver a financial plan to a customer. March 23, 2006. FPA submits written brief to court citing that the SEC improperly created a new exemption for the brokerage industry that defies congressional intent and puts the investing public at risk. May 11, 2006. SEC responds to FPA's brief, challenging its standing to bring the lawsuit, and contesting its version of legislative history. May 25, 2006. FPA responds to SEC. October 5, 2006. Oral arguments are held in FPA v. SEC in the U.S. Court of Appeals for the District of Columbia Circuit. March 15, 2007. FPA seeks formal interpretative guidance from the SEC in understanding the differences between financial planning and fee-based brokerage services under the broker/dealer rule. FPA also notes clear violations of the financial planning and disclosure requirements, and questions timing of the delivery of the required disclosure of potential conflicts of interests by brokers as inadequate. March 30, 2007. U.S. Court of Appeals for the District of Columbia Circuit rules in FPA's favor in FPA v. SEC in a 2-to-1 decision, vacating the broker/dealer rule in its entirety. The ruling of the U.S. Court of Appeals for the District of Columbia Circuit and the legal briefs filed in the case can be reviewed online at www.FPAnet.org/member/govt_relation/lawsuit-against-sec-broker-dealer-rule.cfm.

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