Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609.
Comment to File No. S7-25-99, Certain B/Ds Deemed Not to be Investment Advisers
Dear Mr. Katz:
Thank you for taking comment on Release Nos. 34-42099; IA-1845; File No. S7-25-99, Certain Broker-Dealers Deemed Not To Be Investment Advisers.
The Commission is quite correct in noting that times have changed. However, the proposal would take the investment industry back in time, not move it forward. Therefore, the proposal should be rejected.
The Commission makes the assumption that pricing of brokerage services have changed, not the fundamental services offered. This is incorrect. The entire brokerage industry has, and is, making a huge shift toward becoming more "advisory" in nature, and is implementing fee-based accounts as part of this welcome change. Instead of exempting huge swaths of the brokerage industry from the protections the Advisers Act offers, regulators should be moving in the opposite direction--to upgrade investor protection and disclosure within the brokerage industry by expanding the Adviser Act's coverage.
One cannot assume that in 1940, Congress would not have intended modern fee-based financial planning and investment management to be covered under the Advisers Act. Yet, the release makes this assumption in saying, "The proposed exception would be limited to circumstances where the Commission believes that Congress did not intend to apply the Advisers Act." The SEC is proposing a bold historical guessing game.
The proposal fudges the concept of receiving compensation for "incidental" advice. While in the era of fixed commissions and transactional brokers, the bit of advice thrown in may indeed have been incidental, that state of affairs went out the window with May Day. Clearly now, when the cost of a trade is nearing zero, an investor who pays 1% or more per year for an account in which they may do little trading is obviously paying for advice. Any broker or senior manager at a securities firm will readily and enthusiastically explain that the price they charge is for advice, not transactions. The industry push to fee-based accounts is driven largely by the desire to position brokers as advice-givers, not transaction providers. Why does the Commission insist on arguing that the business really has not changed, other than its pricing arrangements?
The release is also incorrect in assuming that fee-based accounts reduce conflicts of interest. Fee-based accounts allow a firm and/or a broker to create a predictable revenue stream of 1%-3% a year, versus, say, charging 1% once to buy and hold a portfolio of stocks. The Commission must not read altruistic motives into the securities industry's efforts at growing fee-based business, and in seeking an Advisers Act exemption. Chairman Levitt and his Tully Commission are well-intentioned in promoting fee business, but this does not mean there is no conflict in charging fees.
How can the Commission justify saying that "it is highly likely that investors will perceive such [fee] accounts to be advisory accounts"? Surely the Commission is not relying on the 1978 release it cites. Ask a person on the street (or the Street), today, what an "advisory" account is. They will probably be unable to answer. Ask them why they do business with Merrill Lynch, Salomon Smith Barney, etc., and they will tell you it is because of the value of the advice they get.
The Commission is well aware that the NASD and its member firms have been pushing for regulatory control over advisers, arguing that advisers are too lightly regulated. So why do they need an exemption from the Advisers Act?
At the same time, the Commission is considering more burdensome reporting requirements on form ADV (Release No. IA-1862; 34-42620; File No. S7-10-00). The agency makes many stern warnings in this other release about the possible dangers in dealing with advisers who charge commissions, and engage in certain other practices routinely followed by brokers. So why propose exempting brokers, while tightening the screws on advisers? The SEC's regulatory initiatives, seen as a whole, smell discriminatory and anti-competitive.
Exempting dealers from the Advisers Act will allow the continuation of brokerages' poor record of disclosure. The lack of disclosure is broad--undisclosed "revenue sharing" deals and other vendor support payments; undisclosed incentives for selling certain products; undisclosed markups/downs; and vague and confusing disclosure by prospectus only. The exemption is being sought to continue this practice of slipshod disclosure. Brokerage firms, for example, routinely put commissioned products (such as syndicate or UIT-type products) into fee-based brokerage accounts. They simply don't want this "double-dipping" made clear as they would have to under Adviser Act requirements.
Brokerages also do not want the liability under the Advisers Act. Not a single Wall Street firm to this commentator's knowledge has ever supported the concept of "broker as fiduciary," even though many individual registered representatives take pride in a fiduciary relationship with their clients. Indeed, Wall Street firms call their reps "financial advisors" or the like. Financial planning is encouraged. The patina of an advisory relationship is buffed bright. But Wall Street seems satisfied with the simple façade, and this proposal would help polish the marketing sheen. The SEC should instead promote fiduciary status for all financial "advisers," however they are compensated. This proposal does the opposite, by strengthening the status quo of brokers as simple "purveyors of product." Consumers do not understand this important distinction. The Commission should not be an accomplice to the obfuscation.
Wall Street firms have argued that being subject to the Advisers Act hinders advising on fixed-income accounts where trading is typically done on a principal basis. This issue can be handled on a discreet basis, which the Commission has been doing. The ultimate solution, of course, is a national market system for bonds and a vibrant agency bond business. But Wall Street has lobbied against such a national market idea. It should not now be rewarded with a blanket exemption for principal-trading restrictions.
The same firms lobbying for this rule already manage huge amounts of client assets in wrap programs, under which both the individual broker and firm fall under the Advisers Act. Here, the Act has been no burden whatsoever.
In short, the release takes a piecemeal approach to an important issue, and then backtracks the wrong way. Complying with the Advisers Act is not unduly burdensome, given the investor protections gained. An exemption for securities firms is not warranted.