SEC Re-proposes Rule Exempting Certain Broker-Dealers from Registration Under the Investment Advisers Act of 1940

Special from David Goldstein and Jay Gould, White & Case LLP

On December 22, 2004, the Securities and Exchange Commission (the �Commission�) unanimously determined to propose a rule under the Investment Advisers Act of 1940 (the �Advisers Act�) that would exempt certain broker-dealers from the registration requirements of the Advisers Act. The proposed rule recommended by the staff of the Division of Investment Management (the �Staff�) is a modified version of a rule originally proposed by the Commission in 1999. In addition, the Commission has adopted a temporary rule providing an exemption from Advisers Act regulation for broker-dealers who currently offer fee-based and asset-based pricing to customers if the advice such broker-dealers provide is incidental to services provided, regardless of the form of compensation. This temporary rule is scheduled to expire on April 15, 2005, pending consideration of a final rule. The new proposed rule, which should be available on the Commission�s website in early January, will make clear that the position the Commission took on December 22 supercedes the no-action position taken in 1999 in conjunction with the 1999 proposal.

Under the 1999 proposal, certain broker-dealers would not be treated as �investment advisers� to the extent they offered advisory services (1) on a non-discretionary basis and (2) �solely incidental to� broker services, (3) and declared to clients that the accounts are brokerage accounts. Broker-dealers overwhelmingly favored the 1999 proposed rule while registered investment advisers, financial planners, and consumer groups strongly opposed it.

In the Staff�s opinion, the comments received regarding the 1999 proposal indicate that it did not satisfactorily set out the scope of advisory services that broker-dealers can offer without being subject to registration under the Advisers Act. The Commission agreed that the manner in which a broker-dealer is paid is inadequate as a bright-line boundary to delineate the regulatory obligations of service providers, and that the analysis should instead focus on the nature of the services provided and the relationship between the investor and the service provider.

In order to address these issues, the Commission will re-propose the rule for additional comments with the following modifications as recommended by the Staff:

1. Disclosure requirements will be expanded to address the confusion surrounding differences between brokerage and advisory accounts, ensuring that advertisements, agreements, contracts, applications and other forms governing account operations contain a prominent statement that an account is a brokerage account and explaining the difference between a brokerage and advisory account, including the potential absence of a fiduciary relationship. Such a disclosure would direct investors to a person at the brokerage firm for a full explanation of the difference between brokerage and advisory services.

2. The Commission will provide guidance on when advice is incidental to brokerage, including examples of advisory services that are not �solely incidental.� As per the Staff�s recommendation, �incidental� means that the advice is given in connection with and reasonably related to the brokerage services provided. The Commission will solicit comment on whether common types of services provided by brokerage firms are inconsistent with the �solely incidental� concept. Special attention will be given to the financial-planning aspects of services traditionally provided by full-service brokerages, especially with respect to determining suitability of investments. Comment will be sought on whether and how broker-dealers should be allowed to hold themselves out as providing financial planning services and to provide such services without crossing the �solely incidental� threshold.

3. Finally, in line with the Staff�s and the Commission�s belief that the �special compensation� test to determine the boundary between brokerage and advisory services is flawed, the text of the proposed rule will use the discretionary nature of accounts as a bright-line basis for determining whether they are advisory accounts.

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