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U.S. Securities and Exchange Commission

Speech by SEC Commissioner:
Remarks before the open meeting regarding the IA/BD Rule


Cynthia A. Glassman

U.S. Securities and Exchange Commission

Washington, D.C.
April 6, 2005

Thank you. Broker-dealers and investment advisers, including financial planners, generally perform different functions, and operate under different regulatory regimes. However, their activities sometimes overlap, causing competitive issues and investor confusion. One of these overlaps - and the one that concerns us today - is providing investment advice.

Congress recognized in 1940 that broker-dealers gave advice to their customers, but since they were already subject to regulation, Congress exempted them from the Investment Advisers Act, so long as their advice was "solely incidental to" the brokerage business and they received no special compensation for it. The concept of "solely incidental to" has never been easy to define. Special compensation, denoting advice paid for by a fee, used to serve as a convenient dividing line for determining which broker-dealers would have to comply with the Investment Advisers Act, but the development of fee-based brokerage accounts has blurred the line. At the same time, broker-dealer marketing, along with the titles their representatives use, has increased investor confusion about the duties and obligations they are owed by investment professionals.

The rule we consider today permits broker-dealers to offer fee-based accounts without having to register under the Advisers Act, with certain exceptions and provided certain disclosures are made. The notion is that fee-based accounts may be a better choice than commission-based accounts for investors with active trading, so we do not want to inhibit their appropriate use. As I understand it, the NASD expects its members to conduct initial and ongoing periodic reviews to make sure that fee-based accounts are appropriate for their customers, and the NYSE has proposed similar guidance.

Although fee-based accounts further blur the line between brokers and investment advisers, their respective regulatory regimes remain distinct. Broker-dealers are subject to a comprehensive regulatory scheme that protects investors in many ways. Generally speaking, when a broker makes a recommendation, the recommendation must be a suitable, although not necessarily the best, recommendation for the client. However, broker-dealers ordinarily do not owe their clients duties of loyalty that would require them to make up-front disclosure of each and every conflict. But, when a broker has a relationship of trust and confidence with his customer - and this depends on the facts and circumstances of each individual case - the broker does owe his customer a fiduciary duty to put the customer's interest first. This adds a layer of complexity that makes it difficult to generalize about the duties that attach to a brokerage account.

So, absent a fiduciary duty arising from a relationship of trust and confidence, a broker does not have a duty to disclose all conflicts. I note that we are currently working on a proposed form disclosing financial conflicts of interest that brokers would be required to provide to mutual fund customers at the "point of sale."

By contrast, investment advisers are always full-fledged fiduciaries. As a consequence, they owe their clients a variety of fiduciary duties, which includes a duty to disclose conflicts, financial and otherwise - at the beginning of the relationship -- and overall, a duty to put the investor's interests first.

In order to make decisions about which type of account makes the most sense for them, investors should understand the differences between brokerage and advisory accounts. As a result, in this rule, we have focused on both disclosure and clarification of "solely incidental to" to exclude discretionary accounts and financial planning services. Regarding the disclosure, it has been a challenge to reduce a complicated legal analysis of the duties attendant to brokerage and advisory accounts, which may vary depending on the governing state law and the broker's relationship with the client, into a short, succinct and accurate generic paragraph. The disclosure we originally proposed was intended to convey that fee-based brokerage accounts are not advisory accounts, and that there are differences between brokerage and advisory accounts, including the extent to which the broker has a fiduciary obligation.

Our Office of Investor Education and Assistance arranged for the language to be tested on actual investors. The results, which mirrored the findings of some consumer groups, are included in the comment file. It turns out that our proposed disclosure, while successful in alerting investors to the need to ask questions about the differences between brokerage and advisory accounts, was clearly not successful in answering these questions. Focus group participants did not appreciate the distinctions among various financial professionals. Many appeared to think that anyone with a title other than broker - whether "financial advisor" or "financial consultant" - was something more than a broker. The investors in our focus groups also lacked a clear understanding of investment advisers. Many assumed that investment advisers, financial advisers and financial consultants all provided some level of financial planning. So instead of resolving investors' issues, the language we proposed simply raised their anxiety level. As a result, we have modified the disclosure as best we can.

What I have learned from our investor outreach, comment letters and discussions in reaction to the rule proposal, is that the issues we are grappling with here do not apply only to fee-based accounts, which at this point account for less than 10 percent of the total securities held by individual investors. Investor confusion about the obligations their financial service provider owes to them also extends to commission-based accounts.

However, this rulemaking under the Advisers Act is not the appropriate vehicle for dealing with the whole problem. Therefore, I support dealing only with the fee-based account issue here and dealing with the broader issue in prompt next steps. For the short term, I support considering other alternatives - NASD or Commission rulemaking, or both -- that would address the advertising of brokerage accounts in general, not just fee-based accounts. In my view, whether the customer opens a traditional brokerage account or a fee-based account, if the broker-dealer advertises in a way that suggests, implicitly or explicitly, that a fiduciary obligation will attach to the client relationship, the broker should be held to a fiduciary standard.

For the longer term, I support considering a study that would examine the need to rationalize broker-dealer and investment adviser regulatory regimes from the perspective of retail investors.

Therefore, after much discussion and deliberation, I believe that today's final rule and the proposed next steps for further examination of the broader issues is the best way for us to proceed. I fully support this recommendation, and look forward to a prompt follow-up on the remaining issues.

I would like to thank the staff from IM, Market Reg, GC, Investor Ed, OEA and all the commissioners' offices for their hard work during the many iterations of this rulemaking.


Modified: 04/07/2005