May 11, 2000
By U.S. Mail and Electronic Filing
Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549-0609
Re: Release No. IA-1869; File No. 4-433, Roundtable on Investment Adviser Regulatory Issues
Dear Mr. Katz:
I am writing to provide information on the Securities and Exchange Commission's (the Commission) proposed agenda for the Roundtable on Investment Adviser Regulatory Issues. The CFP Board1 appreciates this opportunity to provide information it hopes is helpful to the Commission in deliberating the issues panelists will discuss during the Roundtable.
Investment Advisers and Broker Dealers -- Are the Lines Blurring? (Proposed Rule 202(a)(11)-1: Deeming Certain Broker-dealers Not to be Investment Advisers)
Concerning the proposed rule regarding the application of the Investment Advisers Act of 1940 (Advisers Act) to broker-dealers which are beginning to offer brokerage services for an asset-based fee instead of traditional commissions, the CFP Board believes the Commission has correctly assessed market conditions concerning changes in the brokerage business. Broker-dealers and their traditional transaction-based compensation business face pressure from clients who are increasingly either interested in low cost transaction services or full-scale advice. This trend has led broker-dealers to promote, for some time, the investment counsel they offer, all the while remaining in the brokerage business. The CFP Board believes the pressure on broker-dealers has become strong enough to warrant a shift from transaction to asset-based pricing. In turn, changes in the broker-dealers' pricing policy have rightly caused the Commission to review this issue. However, the CFP Board is not certain that the proposed rule as it currently exists is the most effective way to address this change.
The advice-driven business broker-dealers are facing is not a new method of providing financial guidance. The trend towards obtaining objective financial advice has developed over the last several decades and has furthered the development of the financial planning profession and interest in the CFP marks. Expansion of client-focused business practices to brokerage firms will benefit consumers, as it has done in the financial planning field. Consumers in the long run will feel more comfortable with investment recommendations that are client-focused, ensuring the economic health of the country and of their own retirement.
The CFP Board wants to point out to the Commission that as an investment adviser may offer advice without discretion (such as the proposed rule requires of a broker-dealer seeking an exemption), all that separates the two under the proposed rule is the concept that the advice is "solely incidental." However, the proposed rule provides no clarification on how the Commission will derive what is incidental advice. If a client is compensating a broker-dealer specifically for advice within the asset-based fee structure, the Commission has an imperative duty to ensure the advice is truly incidental. This can only be achieved if the Commission makes clear determinations for broker-dealers as to the services they may offer and the practices they must follow to be considered offering incidental advice. Additional clarification from the Commission on what is "solely incidental" will give much needed direction to broker-dealers and investment advisers and strengthen consumer protection.
Under this proposed rule, the separation of client accounts into either brokerage or advisory accounts based upon the "solely incidental" basis has far reaching implications. Investment advisers provide their customers with advice under a fiduciary responsibility and therefore have certain disclosure and principal trading obligations. The Advisers Act also prohibits testimonials, while the applicable NASD brokerage account rules do not. Regulation in this area will best serve consumers by ensuring those protections exist wherever consumers receive substantive advice. Regulation should not allow brokerage accounts to serve as advisory accounts with less protection.
If broker-dealers simply define their services as incidental advice to avoid these consumer protections, it could not only harm the investment public, but possibly give broker-dealers a competitive advantage over investment advisers. This in turn would harm Certified Financial Planner and CFP Practitioner businesses. Possibly, a reduction in the number of qualified financial planners would occur and thus reduce access to personal financial planning as a choice for consumers.
The Commission has proposed requiring that "advertisements for and contracts or agreements governing the account must contain a prominent statement that it is a brokerage account."2 The Commission's attention to adequate consumer disclosures is well founded and necessary. The CFP Board's Code of Ethics and Professional Responsibility requires each CFP practitioner to be objective, competent, and fair and to always work in the client's best interest. The Code also prohibits licensees from making any false or misleading communications or advertisements and requires proper disclosures including any potential conflicts of interest, sources of compensation, and relationships with third parties.3 The CFP Board realizes from its own experience in drafting disclosure requirements how important these protections are in any professional relationship. The disclosure requirements in the proposed rule are essential in assuring that consumers receive the same protection with broker-dealers as they find with CFP licensees.
The CFP Board believes it is crucial that the disclosure requirements in the proposed rule adequately inform the consumer of the nature of the accounts (i.e. that they are brokerage and not advisory accounts). However, a simple disclosure statement may not be enough to protect consumers. The Commission and other securities organizations have in recent years begun increasing the attention to investor education due to the their concern over Americans deficient understanding of complex financial issues. Commission Chairman Arthur Levitt himself stated, "The plain truth is that we are in the midst of a financial literacy crisis. Too many people don't know how to determine saving and investment objectives or their tolerance for risk. Too many people don't know how to choose an investment, or an investment professional, or where to turn for help."4 With this lack of consumer understanding, simple disclosure of the nature of the accounts does not suffice. The Commission may find it needs to implement consumer education in this area as well as provide more comprehensive and specific disclosure requirements.
An equally important task for the Commission will be ensuring that broker-dealers closely adhere to the disclosure requirements. Recent advertising by broker-dealers indicates the Commission will need to be extremely vigilant in assuring broker-dealers follow the disclosure requirements. Advertising that would invite a consumer to, "consider your stock broker more of an adviser than a broker" is clearly not within the spirit of the rule and a certain violation of the disclosure requirement.
The Commission may also find additional consumer education is necessary to inform investors of the changes in policy. If changes in the rules do occur, broker-dealers will begin charging for advice, a cost consumers would normally have only seen from an investment adviser. Simply changing the rules and then not informing the public of this change could cause unnecessary and damaging confusion.
Effectiveness of Bifurcated Regulatory Regime Under NSMIA
The CFP Board believes NSMIA has had positive effects upon securities regulation and in turn what that has meant for the investment advisory portion of financial planning. In particular, the division of investment adviser regulation between the Commission and the state securities regulators has allowed each authority to focus on the entities most closely aligned with their charge.
Small advisers are now almost solely supervised, and much more uniformly, by what has been called the "securities cop on the beat," the state securities regulator. NSMIA has encouraged the growth of state regulation of investment adviser representatives and brought about greater standardization in investment adviser regulation. These changes mean better protection for consumers and a more uniform regulatory environment for financial planners. Before Congress, one securities regulator stated NSMIA has shown that "...it is possible to bifurcate without weakening regulatory oversight or unduly confusing the marketplace."5
Prior to NSMIA, duplicate regulatory responsibilities prevented the best use of resources for adequate supervision. Before the bifurcation of investment adviser supervision, smaller investment advisers were examined on average, only once every 44 years. Congress found troubling the fact that "many investment advisers hold themselves out to the public as `REGISTERED WITH THE SEC,' a statement that may give investors a false sense of confidence particularly if the investment adviser has never actually been inspected by the Commission and is in little danger of any imminent inspection."6 Now, investment advisers registered with the Commission are inspected every five years.7 In turn, state securities regulators can now focus on the smaller advisers operating within their borders.
Congress expressed a desire for states to fulfill the primary roll in regulating small investment advisers whose activities are likely to be concentrated in their home state. It also felt that larger advisers that operate on a national scale, should register with the Commission and be subject to national rules. The solution it devised was dividing regulatory responsibility.8 This solution does not prohibit however, both the Commission and the states from bringing anti-fraud actions against investment advisers regardless of the entity with which they are registered.
The CFP Board also believes the flexibility NSMIA has given the Commission and state securities regulators is beneficial to both consumers and investment advisers. NSMIA generally prohibits investment advisers who manage less than $25 million from Commission registration but allows the Commission authority to grant exemptions from the prohibition. The Commission may allow registration with it for those advisers whom registration would be "unfair" or a "burden on interstate commerce." NSMIA also has allowed the Commission to adopt rules that allow for investment advisers to keep their registration with a state or the Commission even in instances where its assets under management fluctuate above and below the required $25 million threshold.9
NSMIA's bifurcated regulatory scheme also spurred the establishment of a database to receive inquiries regarding disciplinary actions and proceedings regarding investment advisers and their associated persons. In an effort to more efficiently and effectively regulate investment advisers and investment adviser representatives, NASAA in cooperative effort with the SEC, is developing a national investment adviser database, the Investment Adviser Registration Depository (IARD). This new database should benefit investors and personal financial planning professionals by reducing regulatory and paperwork burdens for registered investment advisers. It will also facilitate supervisory coordination between the states and the SEC.
It has the potential of working seamlessly as well to automatically verify the status of certain professional designations and certifications, including the CFP marks. It is expected that information from the IARD will be available to the public via the Internet. Certain investment adviser information and disciplinary history will be available for any member of the public to see. This will aid investors in choosing competent and appropriate individuals from which to gain financial advice.
The CFP Board believes NSMIA will help address what had become, "a crazy-quilt pattern of jurisdiction over the regulation of securities professionals."10 Overlapping missions and redundant regulatory requirements proved costly to investment advisers while providing no significant added protections for consumers. While it is likely Congress will again take up revisions to the Investment Advisers Act of 1940 in a bill popularly known as the Securities Markets Enhancement Act (SMEA), NSMIA has set a beneficial precedent for all those concerned with effective, workable, and comprehensive securities regulation.
Is There a Need For a Self-Regulatory Organization?
The CFP Board believes securities regulation should be designed with protection of consumers as its primary focus, all the while realizing that a healthy securities industry is vital to consumers ability to meet their financial objectives. Before any action on the creation of a self-regulatory organization (SRO) takes place, Congress should conduct thorough research and investigate the current regulatory scheme for investment advisers. If hearings do take place on the matter, the CFP Board would be able to provide expert testimony on its related long experience as the de facto "Financial Planner SRO."
Revisions to Form ADV
The CFP Board will be providing more detailed information on the Commission's proposed revisions to Form ADV in a separate letter related solely to that topic. However, the CFP Board takes this opportunity to state its belief that inclusion of professional designations and certifications in Part 2A11 is very beneficial to consumers.
Financial planners can help consumers meet life goals and achieve financial well-being. Life goals can include buying a home, funding a child's education, passing along a family business, or planning for the years after retirement. It allows one to understand how each financial decision affects other areas of personal finances. Very often, but not always, financial planning involves investment advice. Consequently, consumers seeking financial planning will at the same time often be seeking investment advice. The CFP Board believes they should take every step possible to assure the investment advice they receive is provided by someone who is competent and trustworthy.
The CFP and Certified Financial Planner marks help consumers identify financial planners who are committed to competent and ethical behavior when providing financial planning services. CFP Practitioners have taken the extra step to demonstrate their professionalism by voluntarily submitting to the rigorous CFP certification process. In addition to significant education and experience requirements, they must pass a comprehensive examination that tests their personal financial planning knowledge and skills (including investment advice), complete a minimum of 30 hours of continuing education every year, and abide by a strict Code of Ethics.
In addition, CFP Practitioners follow certain standards - called practice standards - when they provide financial planning advice. Practice standards describe the process consumers should reasonably expect a financial planner to use during a financial planning engagement. These standards are based on a six-step financial planning process, documented through CFP Board research.12 The steps for the financial planning process are as follows:
1. Establishing and defining the client-planner relationship
2. Gathering client data including goals
3. Analyzing and evaluating the client's financial status
4. Developing and presenting financial planning recommendations and/or alternatives
5. Implementing the financial planning recommendations
6. Monitoring the financial planning recommendations
Considering the preceding rigorous standards, consumers are well served if they are informed of an investment advisers attainment of the right or loss thereof to use the CFP and Certified Financial Planner marks.
The IARD: New Electronic Filing System
The CFP Board believes the Investment Adviser Registration Depository (IARD) will be beneficial to investors, financial planning professionals, and securities regulators.
As the CFP Board understands the project, the IARD will include information on the required examinations of investment advisers or investment adviser representatives (advisers). In order for an adviser to register, they must prove passage of certain securities examinations or maintain various professional designations, including the CFP mark.
The CFP Board has expressed its willingness to participate in an automated licensee verification process. This would allow state securities regulators to automatically verify through the IARD that an adviser who is a CFP licensee and seeking an exemption from the examination requirements maintains a current license with the CFP Board. This will dramatically reduce administrative costs, lag time, and potential errors for regulators. These operating efficiencies will benefit the registration process for those financial planning professionals who provide investment advice.
The CFP Board understands the IARD will likely include for public viewing, any current designations and/or certifications for each adviser via IARD's public Web site. If the IARD provides information about each designation and certification and its subsequent awarding organization, investors will increase their knowledge about financial services and sources of competent and ethical advice.
According to the CFP Board's understanding, the IARD will also include disciplinary history for public viewing. As the CFP Board makes its own disciplinary actions public, we are well aware of the benefit this provides consumers in seeking ethical advice and also of the deterrent it creates for CFP Practitioners in every financial planning action they take.
The CFP Board hopes the information it provided is useful to the Commission, panelists, and attendees during the Roundtable. If you should have any questions regarding the CFP Board, CFP licensees or the CFP marks, please contact me at 703-414-5814 or visit the Board's Web site at www.CFP-Board.org.
Michael C. Herndon
Manager, Government Relations
1 Founded in 1985, the Certified Financial Planner Board of Standards, Inc. (CFP Board) is a Denver based nonprofit professional regulatory organization whose mission it is to benefit the public by fostering professional standards in personal financial planning. The CFP Board owns the marks CFP and Certified Financial Planner, and the CFP flame logo design mark and licenses individuals who meet its certification standards to use them. There are currently over 35,000 CFP professionals nationwide and 10 international affiliates that license additional thousands of qualified persons outside the U.S. The CFP Board also serves as an educational resource to federal and state lawmakers and regulators on personal financial planning issues.
2 Certain Broker-Dealers Deemed Not To Be Investment Advisers, Release Nos. 34-42099; IA-1845, November 4, 1999.
3 CFP Board's Code of Ethics and Professional Responsibility (1999)
4 Levitt, Arthur, Chairman, U.S. Securities & Exchange Commission, speech at the Media Studies Center, New York, NY, April 26, 1999
5 Geyer, Thomas E., Commissioner Of Ohio Division Of Securities, Chair, Securities Activities Of Banks Project Group North American Securities Administrators Association, Inc., testimony before the U.S. Senate Banking, Housing And Urban Affairs Committee, Washington, DC, February 24, 1999
6 Senate Report 104-293, 104th Congress; 2nd Session, For Securities Investment Promotion Act Of 1996, Sponsor: Mr. D'amato, Committee: From The Committee On Banking, Housing, And Urban Affairs, June 26, 1996
7 SEC 1998 Annual Report, U.S. Securities and Exchange Commission, Washington, DC, 1999
8 Senate Report 104-293, 104th Congress; 2nd Session, For Securities Investment Promotion Act Of 1996, Sponsor: Mr. D'amato, Committee: From The Committee On Banking, Housing, And Urban Affairs, June 26, 1996
9 Friedman, Howard M., Professor of Law at the University of Toledo, The Business Lawyer, 53 Bus. Law. 511, Section: Symposium: The Impact of NSMIA on State Regulation of Broker-Dealers and Investment Advisers, February, 1998
10 Friedman, Howard M., Professor of Law at the University of Toledo, The Business Lawyer, 53 Bus. Law. 511, Section: Symposium: The Impact of NSMIA on State Regulation of Broker-Dealers and Investment Advisers, February, 1998
11 Electronic Filing by Investment Advisers; Proposed Amendments to Form ADV, Release Nos. IA-1862; 34-42620; File No. S7-10-00, April 17, 2000.
12 Certified Financial Planner Practitioner Job Analysis Study of 1999, Copyright 2000 Certified Financial Planner Board of Standards, Inc., Linda E. Montgomery, Ph.D., Monica Hemingway, Ph.D., Kathleen T. Jones, Jim Masters, The Chauncey Group International, A Subsidiary of Education Testing Service, Princeton, New Jersey, January, 2000.