Division of Investment Management:
SEC Roundtable on
Investment Adviser Regulatory Issues

The conference consisted of a series of panel discussions moderated by officials from the Commission's Division of Investment Management. Topics of discussion included modernization of adviser regulation, the distinctions between advisers and broker-dealers, adviser trading practices including the use of soft dollars and the obligation to seek best execution, personal trading and other conflict of interest issues, pay-to-play practices, advertising and performance reporting, technology and adviser regulation, and a new electronic filing and registration system for investment advisers. The complete agenda for the conference is at http://www.sec.gov/news/press/2000-56.txt.

The panelists and the public were invited to submit written comments on the issues discussed at the Roundtable. All such comments are available for review and copying in the Commission's Public Reference Room. Comments that were received electronically are available on the SEC website.

Note:  This transcript was prepared by a certified court reporter. The Securities and Exchange Commission is not responsible for the accuracy of this document.

Paul F. Roye
Director
SEC – Division of Investment Management

Arthur Levitt
Chairman
SEC

Panelists
Phyllis Bernstein
Director of Personal Financial Planning
American Institute of Certified Public Accountants

Roy T. Diliberto
President
The Financial Planning Association

Paul S. Gottlieb
First Vice-President and Assistant General Counsel
Merrill Lynch Pierce Fenner & Smith Inc.

R. Clark Hooper
Executive Vice President
National Association of Securities Dealers Regulation

Joanne T. Medero
Managing Director and Chief Counsel
Barclays Global Investors

Robert E. Plaze
Associate Director
SEC – Division of Investment Management

Bradley W. Skolnik
President
North American Securities Administrators Association
Indiana Securities Commissioner

David G. Tittsworth
Executive Director
Investment Counsel Association of America

Panelists
Gene A. Gohlke
Associate Director
SEC – Office of Compliance Inspections & Examinations

Paul G. Haaga, Jr.
Executive Vice President and Director
Capital Research and Management Company

Henry H. Hopkins
Managing Director and Chief Legal Counsel
T. Rowe Price Associates

Thomas P. Lemke
Partner
Morgan, Lewis & Bockius

Charles Tschampion
Chairman
Association for Investment Management and Research

12:30 – 2:00

Lunch Break

2:00 – 3:15

Other Conflicts of Interest

Robert E. Plaze, Moderator
Associate Director
SEC – Division of Investment Management

Panelists
Guy M. Cumbie
President-Elect
The Financial Planning Association

Meyer Eisenberg
Deputy General Counsel
SEC – Office of General Counsel

Susan MacMichael John
Government Affairs Liaison
National Association of Personal Financial Advisors

Ellen R. Porges
Managing Director and General Counsel
Investment Management Division
Goldman Sachs

Sandra P. Tichenor
President
Investment Counsel Association of America

Mary Ann Tynan
Senior Vice President, Partner
and Director of Regulatory Affairs
Wellington Management Co., LLP

3:15 – 3:30

Break

3:30 – 4:30

Advertising and Performance Reporting

Douglas J. Scheidt, Moderator
Associate Director / Chief Counsel
SEC – Division of Investment Management

Panelists
Luis Aguilar
General Counsel
INVESCO, Inc.

Michael S. Caccese
General Counsel and Senior Vice President
Association for Investment Management and Research

Thomas M. Mistele
General Counsel, Secretary and Vice President
Dodge & Cox

Kathryn L. Quirk
Managing Director and General Counsel
Scudder Kemper Investments Inc.

Lori A. Richards
Director
SEC – Office of Compliance Inspections & Examinations

Panelists
Jilaine Hummel Bauer
Senior Vice President and General Counsel
Heartland Advisors, Inc.

Scott W. Campbell
Vice-President and General Counsel
Financial Engines Advisers, LLC

Alton "Chip" Jones, Jr.
Vice-President of Securities Affairs
Regulatory and Industry Affairs
American Express Financial Advisors

Melanie Senter Lubin
Chair
Investment Adviser Section
North American Securities Administrators Association, Inc.

John D. Markese, Ph.D
President
American Association of Individual Investors

Craig S. Tyle
General Counsel
Investment Company Institute

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Mr. Roye:  Good morning. My name is Paul Roye and I am Director of the Division of Investment Management. It is truly a pleasure to welcome all of you to our roundtable on Investment Adviser Regulatory Issues. I am glad to see that we have such a big turn out. Although I am not surprised because we have an impressive group of panelists and a host of timely and engaging issues to explore. As all of you know or you would not be here, this is an exciting and dynamic time for the investment advisory industry. With major rule proposals pending and others to follow shortly. Chairman Levitt felt that now was the time to take a step back to review the state of the industry and the state of our regulation of the industry and consequently yes, the Division so we organized this roundtable.

The Investment Advisers Act is enjoying its sixtieth year since enactment. It is an amazingly well crafted statute that with relatively few amendments has withstood the test of time. Nonetheless, we at the Commission must be ever vigilant in reviewing the regulatory framework and in reviewing our rules and regulations. This has never been truer than now when we are in the midst of an intense period of tremendous technological change and innovation that I believe will truly be viewed as a watershed period for our securities markets and the investment management industry.

Now after the passage of the NSMIA legislation in 1996, the Division of Investment Management formed the Task Force on Adviser Regulation to implement the provisions of that legislation. We are currently engaged in revisiting our regulatory approach on many issues under the Advisers Act in a comprehensive effort to modernize our regulations to respond to the changes that are sweeping across all financial services industries. The purpose of this roundtable is to elicit the views of consumers of investment advisory services, the industry, and state and federal regulators regarding the state of the industry, where it is headed and how the industry should be regulated.

Before we begin the first panel, I would like to ask Chairman Levitt to make a few remarks. As all of you know, in his remarkable tenure at the Commission, Chairman Levitt has distinguished himself as not only the longest serving chairman of the SEC but also for his energetic devotion to satisfying the Commission's mandate to serve as the investors' advocate. He has continually spoken out on preserving the high fiduciary standards that are hallmarks of the investment advisory profession and he has be a proponent of forums like this to seek the views of interested parties. Chairman Levitt.

Chairman Levitt:  Good morning and thank you Paul.

Today more and more Americans are investing in stocks, in bonds, in our markets whether they are investing through pension funds, investment companies, endowments, charitable trusts, thousands of individual portfolios. Investors have placed over $18 trillion under the care of people such as yourselves. Never before have the roles and the responsibilities of all of you in the investment management industry been more crucial to protecting more and more of America's citizens. The profound and far reaching changes sweeping our market place demand that we remain proactive in reexamining the way the profession carries out its fiduciary responsibilities. New imperatives demand that we embrace the benefits of technology. To streamline industry oversight and more importantly to serve a more informed and a more energized investor base.

After nearly six decades since enactment of the Investment Advisers Act, the Commission has undertaken a comprehensive effort to modernize the regulations that govern advisers. Under Paul's leadership and with the tireless efforts of Dave Fielder, Paul's adviser, today's roundtable brings together representatives from advisory firms and their trade associations, state regulators, consumer advocacy groups and the NASD to discuss proposed rules and the many issues, challenges and opportunities before us.

The Commission's modernization drive began almost five years ago after the passage of the National Securities Markets Improvement Act which was aimed at establishing sensible jurisdictional boundaries between the SEC and the states' regulation of advisory firms. Among other benefits, the initiative eliminated duplicative regulation of investment advisers. Today, approximately eight thousand investment advisers are registered with the Commission and another 12 thousand are registered with state securities regulators. The Commission today has several pending rule proposals that we believe represents significant steps toward continuing our commitment to modernization of investment adviser regulation.

One of these initiatives is the Investment Adviser Registration Depository or IARD. This Internet based filing system will enable investment advisers to satisfy their reporting obligations under both state and federal laws with a single electronic filing. The system will help us better monitor advisers to analyze the impact of regulatory changes and to anticipate areas that may require special attention. Most importantly, investors will be able to access the system free of charge through the Internet.

The proposal also requires that all advisers provide clients with a kind of narrative brochure that will be written in plain English. Now this document will contain meaningful disclosure about the advisory firm. In addition, a new updated Form ADV would provide even more information to investors, specifically when it comes to financial conflicts of interest between advisory personnel and their clients. This also means enhanced disclosure of soft-dollar practices.

Another pending proposal addresses the issue of precisely when broker/dealers are subject to regulation under the Advisers Act. Many full service brokerage firms now charge asset based fees rather than commissions for their services. This new pricing of brokerage services is responsive to the best practices identified in 1995 by the Committee on Compensation Practices and better aligns the interests of brokers, their registered representatives and their clients. We recognize though that the Commission needs to address the fundamental issue of what distinguishes broker/dealers from investment advisers. Toward that end our pending rule proposal seeks to delineate advisory services from brokerage services based on the nature of the services provided rather than the form of compensation received. More specifically, if a broker has discretionary authority to trade securities in an account and charges an asset based fee, the account would not qualify for exemption from the Advisers Act. But if the broker does not have discretionary authority, the Act generally would not apply. We are sensitive to many of the concerns that a number of you have who feel that these asset based brokerage accounts have the potential to mislead investors.

Currently, the proposal requires that all ads and agreements for exempted accounts contain a prominent statement declaring that the accounts are in fact brokerage accounts. Based on your comments asking for greater safeguards however, the Commission is now considering more specific disclosure requirements for the final rule.

Finally, I know that many of you are familiar with our rule proposal addressing pay-to-play in the investment adviser area as well as the rather enormous controversy it has generated. But few can disagree that pay-to-play is entirely inconsistent with the high fiduciary standards of investment advisory professionals. While we've received many comments questioning the approach and the scope of the proposed rule, we remain convinced that a rule is long overdue. The Commission must and will act by specific regulation to prevent the practice of buying government business with campaign contributions. It is simply the right thing to do. We are mindful however that differences between the municipal finance industry and the advisory industry might warrant somewhat different regulatory approaches. We are pleased that the Investment Council Association of America has recommended best practices for advisory firms to prevent pay-to-play practices. We are going to evaluate these best practices as we begin to craft our final rule. Working together, the SEC and the advisory industry I believe can eliminate the abusive practices that undermine the integrity of the adviser selection process.

As we move forward on these and other initiatives in investment advisory regulation, we intend to address a number of issues, including the circumstances under which an adviser can engage in principal transactions, revisions to our advertising rules to provide for greater flexibility and enhanced investor protection and possibly mandating that advisers have codes of ethics addressing personal trading. I really believe that the future success of the investment management industry depends on an unwavering commitment to the very highest fiduciary standards first embodied in the Investment Advisers Act of 1940 and honored by the profession ever since. While much as changed over the past sixty years, the guiding principles of the investment adviser profession remain timeless. The adviser's role is still built on a relationship of trust, a promise of integrity and a covenant between fiduciary and client. We ask that you work with us in preserving the high fiduciary standards of your profession that have been and will continue to be the bedrock for enduring success.

It is our hope today that this forum will result in an interface of ideas; that you will feel free to speak out as well as listen; that we will come away from this with a better feeling for the problems of the industry and that this will result in a commitment between the industry and ourselves to do the kinds of things that will retain the primacy of America's investors as our principal concern.

I think that all of us who have ever had any experience in terms of dealing with clients, whether we be brokers or advisers or investment companies, understand the kind of fragile nature of a relationship of trust upon which our markets depend. If we lose that trust, trust in our markets, trust in the structure of those markets, trust in the rules and regulations that govern those markets and maybe most importantly for our purposes today trust in the independence and the integrity of the people who represent them and represent their futures in a very special way. If we do not have that we do not have markets in this country and none of us have a justification for doing the kinds of things that we are doing. I know that all of you represent a kind of proud heritage. You represent a unique position in the linkage between investors and our capital markets. We respect you for your independence and it is terribly important that the dialog today not be viewed as thunderbolts coming down from Mt. Olympus while you all sit there listening. Hopefully we have a common goal. I think we do and we have to gain a better understanding of how we can be helpful to you and hopefully you will gain a better understanding of what our priorities are in terms of the public interest and if this works right, as I expect it will, we will work cooperatively toward not just preserving but nurturing and enhancing that public interest. Thank you very much.

Mr. Roye:  Thanks for those remarks Chairman Levitt.

He set the stage for our discussions today. Many of the issues outlined in the Chairman's remarks we expect to cover in the course of today's roundtable. Before we get going with the first panel and ask those panelist to come up if they would, I want to take care of a few housekeeping items. First, I'd like to say for myself and on behalf of the Commission staff participating in the roundtable, that the views that we express are our own views and don't necessarily reflect the views of the Chairman and the other Commissioners or other members of the staff.

Now I'd like to briefly go over the structure of how we're going to operate the panels this morning and this afternoon. In an effort to foster a dialog on the issues that we want to cover, we structured each panel in a question and answer format whereby the moderator will ask questions and the panelist will then weigh in with their answers.

Because we have a full agenda and a limited amount of time, we have determined not to take questions from the audience but you may be able to talk to some of the panelist after other panels are over and have some of your questions answered. However, because we wanted to afford interested persons the opportunity to participate, we have a public file that we have created where you can submit your comments on the issues covered in the course of the roundtable. We have already received comments on a number of the issues that we are going to cover today and indeed some of the questions that will be posed to the panelists were crafted from some of the questions that we got from information submitted to that public file. Again, we urge you to submit comments to that public file as we consider some of the issues. We will have a transcript of today's discussions available approximately two weeks after the roundtables over. There are phones out in the hall if you need to make phone calls and upstairs in the lobby. There are restrooms down the hall and with that I want to get started with our first panel.

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II. Investment Advisers in Today’s Competitive Markets/
Modernization of Adviser Regulation

Moderator Roye:  Our first panel will focus on really the role of investment advisers in today's competitive markets and the modernization of the investment adviser regulatory regime. It's more of an overview type panel. We want to focus on whether or not the existing regulatory regime is indeed effective, where it can be improved. The scope of the investment adviser regulatory regime, whether or not some of the exclusions in the statute indeed make sense in today's new economy. So, let me start by introducing our panelists. They are on our first panel and I will introduce them in alphabetical order. We have Phyllis Bernstein who is a Certified Public Accountant. She is the Director of Personal Financial Planning for the AICPA. She spearheads the efforts of the AICPA in the financial planning area. She is responsible for a number of their publications in the financial planning area and is in the process of updating their guidance on how to register as an investment adviser.

Next, we have Roy Diliberto who is a certified financial planner and a chartered financial consultant. He is the President of the Financial Planning Association which is an organization that is the result of the merger of two of the largest financial planning organizations with about 30 thousand members, I understand. He is the President of RTD Financial Advisers Inc., a financial planning and asset management firm in Philadelphia.

Next, is Paul Gottlieb. He is the First Vice President and Senior Counsel for Merrill Lynch. He served as a Chairman of the Securities Industries Association Investment Adviser Committee. Prior to joining Merrill Lynch, he was the Chief Counsel for E.F. Hutton's asset management group where he was responsible for mutual fund and investment advisory issues. He served in various capacities with the Shearson Lehman Brothers and PaineWebber.

Next, we have Clark Hooper who is an Executive Vice President of the NASD Regulation where she has the office of disclosure and investor protection. She has a fairly broad mandate in that position. She is over the advertising regulation arm of the NASDR which is responsible for review of all the advertising communications with the public, the corporate finance group within the NASD, the internet and investor education operations at the NASD, the investment company regulation operations as well as the CRD and public disclosure operations for the NASDR.

Then, Joanne Medero who is Chief Counsel and Managing Director for Barclays Global Investors. She joined Barclays in 1996. Prior to that, she was in the law firm of Orrick & Harrington where she was a partner in their New York office specializing in derivative and market regulation issues. Prior to that she served has general counsel of the Commodities Future Trading Commission and then prior to that was in the office of Presidential Personnel in the White House.

Then, we have Robert Plaze who is an Associate Director in the Division of Investment Management. Bob is responsible for a lot of the policy and rule making initiatives in the Division. He also heads up the Investment Advisers Regulation Task Force and really is the chief architect of the rules and policies in the investment adviser area.

Then we have Brad Skolnik who is President of the North American Securities Administrators Association which I'm sure as you know is the umbrella organization for the states and the provincial securities authorities in the United States and Canada. He is also the Securities Commissioner in the state of Indiana. I think Brad is particularly proud of the fact that in his tenure they have imposed more fines and penalties than any other securities regulator in the state of Indiana. Under Brad's leadership, he has ably lead NASAA in taking a number of steps to promote affective regulation of advisers at the state level.

Finally, we have David Tittsworth who is the Executive Director of the Investment Counsel Association of America. It is a trade association that represents federally registered advisers with about 250 members with $2 trillion under management and prior to that, David had various positions on Capital Hill. He served as counsel to the House Commerce Committee.

Again, this panel as I mentioned was going to focus on the investment advisers regulatory regime. As many of you know the statute in large part is an antifraud statute that requires advisers to disclose conflicts to clients. The Act itself contains very few substantive requirements and most of them really emanate from the antifraud provisions in the statute like the advertising rules, custody requirements, imposing disclosure of financial and disciplinary information on advisers. The first question we want to explore this morning is really does the Act work in today's increasingly complex economy. Can investors make intelligent decisions about investment advisers? Should a different regulatory framework be considered? Are there additional protections that are needed in the investment adviser area? Are there areas in the Advisers Act where maybe there is too much regulation and we need to reduce some of the regulatory burdens? I'd like to start with maybe David Tittsworth and get your reactions about the statute today and its effectiveness or lack thereof.

Mr. Tittsworth:  Thank you Paul. I first want to speak on behalf of everybody here and everybody to follow that we really appreciate the leadership of Chairman Levitt and yourself and your staff for convening this roundtable today. I consider it to be a very historic opportunity. You certainly don't have, well you do have so many other things on your plate it's fairly astounding to me that you took time to include this roundtable on your busy agenda and I just want to express our great appreciation.

I think you have to say that the Advisers Act has worked remarkably well. Sixty years, there has been a hell of a lot of changes in 1940 when the Advisers Act was created. You didn't have a lot of things that you have today. You didn't have television. You didn't have the NASDAQ market. You didn't have the internet, and yet I think that the basic structure has remained intact and serves investors well. And you basically have three pillars upon which the Advisers Act regulations are premised.

First is full and fair disclosure. In my written statement, I go to some length to describe the disclosures that advisers have to provide to their clients. It's unprecedented in terms of how you compare it to other professions that are out there. The second thing Chairman Levitt alluded to in his statement is the fiduciary duty that advisers owe their clients. Again, a very unique aspect of investment adviser law, adviser regulation that fiduciary duty was really articulated by the Supreme Court in the 1963 case Capital Gains. It's been expanded upon and reiterated by the Commission over the years, but it is a key component of an adviser's specific legal regulatory obligations. Then, finally of course you have very broad antifraud authority vested with the Commission that allows it to do a lot of different things to the investment adviser profession. I'm not aware of any fundamental break down that has occurred in the last sixty years in investor protection.

There have certainly been isolated cases, some enforcement actions that were fairly ugly but no systemic problems of abuse. No history of prolific client investor complaints and I think that's attribute to this flexible standard and whatever scheme your going to employ, if you were sitting in Congress in 1940 or sitting in Congress today or at the Commission, you obviously need a fair amount of flexibility and that's to deal with future problems but also the profession itself is very, very diverse and it's getting more diverse all the time.

I think the one problem that has been identified the last sixty years was on really the inspection examination side. It wasn't with the basic legal regulatory framework, but given the growth of the investment adviser profession in the 80's and into the 90's the Commission, Congress itself was faced with the situation where you had virtually – well you had a limited examination oversight of the profession. Testimony of the Commission on Capital Hill back ten years ago or so was that examinations of smaller advisers were occurring only once every forty-four years; other advisers, fifteen to thirty years. However you want to cut it, it was unacceptable. That has all been changed with the advent of the Coordination Act under NSMIA in 1996. I know we will talk about that a little more but I think that's the only real problem that has been identified. Final point and then I'll shut up because I know you want the other people to talk. I do think that there are some challenges that all of us face, policy makers, the Commission, Congress, and the profession itself going forward and those relate to really the scope of the Advisers Act. I think that again, my view is that the Act itself, the legal regulatory frame work is flexible, it's broad, it protects investors, it's adequate, it's effective but who is included in this scope of the Act. Whether it is the broker dealer rule that we're going to talk about or whether it's internet providers that are doing a lot of things that are different and whether or not it's advised, whether or not your providing personalized advice.

I think the ICI has written an excellent paper and I know on the last panel today they are going to talk about some of the implications of technology and changes in the profession. The bottom line is I think that the scope of the Act is definitely on the table and those are probably the most important issues that the Commission and the profession and other policy makers face going forward.

Moderator Roye:  Before we move on to some of the other panelists, let me make a disclaimer on behalf of the panelists as well, that the views that they express are their own views and don't necessarily reflect the views of the firms that they work for, so we have a disclaimer similar to ours.

(Laughter)

Mr. Tittsworth:  I'm going to reject that disclaimer.

Moderator Roye:  Paul Gottlieb: your perspective on the statute.

Mr. Gottlieb:  Thank you Paul. I'm going to basically agree with what we just heard. I think the industry has worked remarkably well and when something works well, we should applaud it and not change it. The industry, the signs of health are really all around. The industry as a whole has grown. Client assets have grown. More and varied products are being offered to clients to meet their needs and while even a single infraction is too much, I think a broad view of the industry is that it works well and the disclosure model has been one that meets the needs of our economy and our clients.

The disclosures required for advisers are indeed formidable and I would compare it truly to any other profession. The disclosures on our policies and procedures and our personnel, on our fee schedules, on the varied items that are both required by the Advisers Act and Form ADV and the other disclosures that we just feel appropriate to explain to clients as they enroll in a program and as they continue a client relationship.

These disclosures are formidable. That's not a complaint by any means. We think that they are appropriate to be disclosed but I think it's fair to state that a high standard has been placed for advisers and that the advisory industry has by in large met the challenge reasonably well.

I'd point out that to call the legal framework a disclosure model is not entirely correct for dual registrants, firms that are both registered broker/dealers as well as investment advisers. There's a substantial body of regulation to be met under the broker-dealer rules and that is again a fairly formidable system of rules to follow that the brokerage industry does comply with and for dual registrants, both the requirements have to be met.

Nonetheless, I think things are working reasonable well. Chairman Levitt mentioned principal transactions, I know that's a topic that is going to be raised later on in the roundtable. That's an important area for reflection and reform as we try to provide the best services and best execution possible to our clients.

Certainly, the consolidation of the industry has made reform here in our minds substantially more important than ever before. So that's a focus for deregulation and further flexibility that is an exceedingly important topic both today and for the Commission as a whole but I think the model has worked well and I think that basic model should continue.

Moderator Roye:  Roy from the perspective of the financial planners, what's your perspective on how the statute and the regulations have worked?

Mr. Diliberto:  Well, I agree also that the Act has worked very, very well. However, I am concerned that if it's not uniformly applied to people who are functionally acting as investment advisers that it's in danger of not protecting the public as it has over the years. I think that uniform regulation under the Act is very, very important from financial planners' point of view. Financial planning as a profession is growing very, very rapidly and there are many organizations and institutions who are jumping on that bandwagon and that's good for the public. However, the public will not be protected in my opinion unless the Act is uniformly applied to all those who are functionally practicing financial planning and investment advice.

So I think the Act has worked. I think it can continue to work but if it becomes watered-down, I am concerned about how it may work in the future. Another question that came up was, "do we need alternate regulation?" One of the things that financial planners would like to see is some kind of regulation for financial planning because investment advice is only one part of what a financial planner does and there are other competency levels that a planner should have and should meet and should be responsible for answering to some regulatory authority to make sure that they are competent in those areas that are being supervised in those areas. At some point, I would like to see that happen.

Moderator Roye:  So Roy your saying that beyond the organizations out there that certify financial planners and apply the standards that you think that there's a need for government regulation of financial planning?

Mr. Diliberto:  Yes, because financial planning is a multi disciplined approach to finances and to regulate only a part of what a financial planner is doing I don't think protects the public as well as an agency that would regulate the entire scope of what financial planners do.

Mr. Plaze:  Roy, the regulation and financial planners rarely what has taken place through private initiatives by the Board of Standards and the marks that it so carefully guards and enforces detailed rules. Do you think that that's inadequate, that government needs to step in and do that?

Mr. Diliberto:  Well, I think it's adequate for those people who are certified financial planners but there are many others who practice financial planning who are not regulated and so that code of ethics and those practiced standards work very, very well and they're stringently applied by the board but there are only 34 thousand certified financial planners and I don't know what the number is but I've heard two hundred, 300 thousand people who hold themselves out as financial planners.

Moderator Roye:  Let me go to Brad, since a lot of financial planners are really registered on the state level as advisers if they're giving investment advice with regard to securities. Do you have any reaction to what Roy said about the need for additional regulation?

Mr. Skolnik:  Roy raises an important question that I think many of us have given thought and consideration to. One problem we confront however is the fact that financial planning is often times really a multi disciplinary type of profession. It involves not only those who hold securities or investment advisory licenses but insurance professionals, certified public accountants and the like. It seems to me if we're going to regulate financial planning as a profession, that both at the federal and state level we're going to really have to make some determination as to what agency or agencies would ultimately have responsibility for oversight.

I know if you look inside the telephone book in any community you're going to find under the heading of financial planners not just investment advisers or broker/dealers, but also folks who are accountants, insurance salespersons or advisers and a number of people who maybe hold more than a single license. I'm not saying that it's something we shouldn't do. It's just a matter of I think we're going to have to look at it a little differently than the way we currently categorize the way services are delivered.

Mr. Plaze:  That would require quite – to achieve that wholesale changes in existed statutory structures which of course involves robbing Peter and paying Paul. Both in terms of the regulator as well as the regulated interest who are becoming attached to their regulatory systems? Of all the systems that regulate, isn't the Advisers Act the broadest one in terms of capturing most people who are actually financial planners because it is very difficult to be a financial planner without giving advice about securities. Is that a fair statement?

Mr. Diliberto:  It's a fair statement that it captures that part of the advice, yes absolutely and most financial planners do provide investment advice so under the current structure it's probably the most likely place for it to fit but it doesn't fit perfectly.

Mr. Plaze:  Some states have advisory laws, which include holding out as a financial planner brings all of those advisers and all those insurance agents and accounts within the advisory statutes based on holding out. Should the federal statue be changed similarly to achieve that Roy, do you think?

Mr. Diliberto:  I would applaud a holding out provision, absolutely.

Mr. Skolnik:  It's a small number of states, if I'm not mistaken that really have that holding out provision in their state law. For example, in my state of Indiana we do not have that so if someone holds themselves out as an investment adviser they fall within the Act but the term financial planner or even financial adviser probably does not fall within any statutory definition.

Mr. Plaze:  That would work as a way from concepts of functional regulation whereas we're regulated based on what you do and what not you call yourself which is, which runs a little bit counter to the direction the Commission policy is going in the past years.

Mr. Diliberto:  Just to add from a consumer's point of view. If the consumer goes to see an adviser who calls him or herself a financial planner, a financial consultant or any one of the number of holding out titles, there should be an expectation on the part of that consumer on what will happen when they see that person and today that doesn't exist.

Ms. Hooper:  If I could just speak up for one moment. I really think Roy has raised an issue that is probably the most forward looking issue that we may discuss because we can look at the variety of different types of schemes of regulation and statutes et cetera but what your raising Roy is something beyond that. Which is really getting at the convergence of the industries and your are right we don't really have anything in place?

First of all we don't have a definition for a financial planner but if you look at what the scope of a financial planner's responsibilities, they're regulated independently and individually and yet to the consumer, to the investor – the one person that we're really trying to protect. Those are transparent. That person is going to a financial planner and they are asking them to help them in a variety of ways. Whether it's estate planning, whether it's purchasing securities, whether it's investment adviser, investment planning and whatever the person is being called and whoever is regulating that individual is totally transparent to the consumer.

So I think that this is really an issue that we all need to look at from a forward looking perspective as to if the industries are going to continue to converge and there's nothing that's giving us an indication that they're going to reverse that trend. Then we need ourselves to be thinking about how we can best do two things. Obviously, first of all protect the investor but maintain the integrity of this industry regardless of how it evolves so that the consumer has the confidence in it. I think it's an excellent point, no answer of course.

Ms. Medero:  I do think though before you suggest a federal solution that you have to find whether there's a problem that needs to be resolved and whether perceptions can be handled through investor education. Which I know a number of private agencies, as well as the SEC, have undertaken.

Mr. Gottlieb:  I guess I would agree with that last comment. Many of these folks are already regulated in one framework or another. Let's be careful in just deciding there's a problem here and slapping another layer of regulation, or another regulator on top of something that's already subject to rules, procedures, disclosures et cetera. For example at the brokerage firms, many brokers even traditional commission based brokers in the ordinary and historical sense pride themselves in providing some planning advice to clients and I think that's something that should be applauded since our emphasis is to get away from the tunnel vision approach on a particular trade and rather provide some broader perspective on how does a particular transaction fit within a broader investment outlook.

So let's be careful. Planning is not an evil word and lets not try to restrict something that we actually want to encourage as far as the provision of advice to clients.

Ms. Bernstein:  A significant number of our members provide financial planning services and financial advice with integrity and objectivity and really have been doing that as part of the profession. So it becomes difficult to say that all financial planners are investment advisers because a significant number of CPA's who are in the business of giving financial advice are not in the business of giving investment advice.

There are significant numbers and growing numbers of our members today who are registering as investment advisers or who are serving as registered reps of brokerage firms. They're in a different business and those members are registered and regulated, but those who are really just giving financial advice and financial planning who are not in the investment area providing tax advice, providing information on retirement distributions on cash strategies, on charitable giving, on estate planning may not be getting involved in the investment area. So I think you have to look at what the person does, what the function really is and not necessarily the nomenclature, what the words are. It's what the person does and I think that's really where the line has to be drawn.

Mr. Skolnik:  I agree that I don't – I abhor the thought of adding more regulation or another layer of regulation. However, I do concur with what Clark said, that the manner in which financial services are delivered today do not fall neatly within the categories established by the 34 or '40 Act or states' securities laws. I think the fact is that the law is set forth in many of our state statutes as well as at the federal level have maybe not kept up with some of the changes that are occurring within the industry. By the industry, I am referring to the broader financial services sector.

Sometimes I'm left with the impression that when we're trying to determine who should be regulated as an adviser as opposed to a broker/dealer as opposed to maybe some other financial professional that we're left trying to almost pound square pegs into round holes.

The fact of the matter is back in the 1930's and 40's so called financial planning and investment advisory and broker/dealer services were much different than they are today and I think it does raise the broad question. Do we need to take a fresh look at the way we regulate the entire profession? I agree with Bob Plaze; that would be a massive undertaking.

Mr. Plaze:  The difficulty you have moving from the current scheme which is based on function to the later scheme which is based off of a financial planner which is a multi-disciplinary exercise by however you define it. I think everybody would agree it involves brokerage, involves investment advice, involves accounting and a number of other services is that you either have two choices to make. Either you have a separate layer of regulation that applies just to financial planners and leave the additional regulatory structures in place for the other functions. Or, you part out a special group of people who call themselves financial planners and regulate them separately and then not regulate them as investment advisers or brokers or accountants. The problem of that approach, I think, will be illustrated if Merrill Lynch decides that it rather be a financial planner not regulated as a broker/dealer. Which is obviously I think an absurd consequence of that latter approach and so you're left with the current approach. You like it or don't like it, is you do have a separate layer of financial planner regulation and it's voluntary regulation.

The marks which are enforced and to the extent that the marks become more popular and more in part a part of marketing financial planning services in today's market place. That effectively it will have greater and greater teeth. I think those choices is what you're faced with in terms of models.

Ms. Hooper:  I also do think however that – I'd like to suggest at least that you don't have to automatically assume there have to be additional layers of regulation. I think it's very critical in fact, that one doesn't do that. Because, we are all trying to get away from duplicative or multiplicative regulation and it's not serving anyone good by having a firm have to submit itself to layer upon layer upon layer of substantially the same types of regulation.

It's an enormous, as I said earlier, it's an enormous question. I do not know how you get it. It's like getting your arms around smoke but I do think that we need to think more forward in terms of the way the industry has developed.

Mr. Plaze:  I guess one of the middle ranges also is trying to adapt the individual regulatory structures more to accommodate financial planning. I know that with our ADV forum that we have recently proposed a number of questions that deal with new issues that come up. For instance, we asked for the first time, "Do you have a professional designation at your financial planner?" "Has that designation been revoked?" Those were not issues twenty years ago.

Moderator Roye:  Roy seems to be suggesting, that at least in the financial planner segment of the industry, that maybe sort of a voluntary self regulation is not sufficient. In the investment adviser area generally the notion of self-regulation periodically rises. Bob maybe you could speak, since you have been here doing some of those initiatives going back to the Commission submitting even a legislative proposal to establish one or more self-regulatory organizations. What is behind those kinds of efforts?

Mr. Plaze:  Well, back in 1988, when we submitted the proposal I had an occasion to do some work on that proposal, we were faced with an exploding population of investment advisers. We were at a crisis here at the Commission. There were almost 6 thousand advisers registered with the Commission. Of course, by the time 1996 came around and legislation was enacted dealing with that issue we had about 23 thousand investment advisers. So we saw it coming. It was mostly dealt to address that issue. The SRO issue came up again in '93 and '94 on the Hill. There was legislation that was introduced that would make the NASD the inspection-only SRO for investment advisers. The board of standards of the institution of CFP's, as again from time to time expressed an interest in being a SRO for financial planners.

Legislation would be required to make a SRO. The SEC could not do that under our statutory scheme by ourselves. The Exchange Act was amended to accommodate a SRO for broker/dealers; the NASD and again it would require legislation. It hasn't happened and I think there are some reasons for that but then again there are some good arguments that you can make for a SRO.

The reasons first, I guess, the con would be that NSMIA, which we will talk about, really addressed our problem in terms of our registrant population, we're down to about 8000 investment advisers. Which with our current staffing, we can handle.

Second, advisers, to some extent are different than broker/dealers. SRO is initially organized for broker/dealers on the notion that they trade together, and there's a lot of interdependency and rules of the road which government was in a good position to dictate. The industry was in a better position to set those rules for its members. Investment advisers do not have that much interaction.

The third reason, and I think this had to do with a lot with why 1988 proposals did not go anywhere. It's an additional layer of regulation and it's a regulation that has to be borne by the people who regulate. There are fees and costs associated with that on top of the current registration regulatory costs on advisers.

Finally, the politics of investment advisers. Question is okay, if you decided your going to have a SRO, then the question is "Who's going to be an SRO?" One thing was consistent in 1988 when we sent that proposal up to the Hill is, a lot of people opposed it but they said, "Well, if you're going to have one that's okay but I don't want that other guy to be the SRO." "I want to be the SRO." "My trade association will step up to the plate but not that other guy." It was a little bit like a circular firing squad and that's why the regulation proposals never went anywhere.

There are a number of pro's here. First of all, again, there is expected to be continued growth in this industry. I presume a good market correction could resolve that but we're all hoping that's not going to happen. Secondly, the continued crisis today in regulation isn't with the volumes but it's with SEC staffing issues.

SRO could pay more market salaries to keep people, a lower turn over. Maybe Clark could talk about her success at doing that at the NASD. Develop by a greater expertise than you are able to the staff here. Where we are able to keep people for 18 months before they leave for higher salaries. Is SRO's closer to the industry? It understands much more is going on as opposed to SEC staff people here in Washington who really isn't in the industry. Utilizing industry committees. Bring a lot of expertise, a lot of knowledge to regulation.

Finally, a SRO can impose tougher standards than the SEC can, which is our regulation of the Advisers Act is based on prohibiting fraud. All of the NASD and other self-regulators impose principles of business. Prevent sharp practices, which perhaps don't rise to the level of fraud but really shouldn't take place in the industry. So there are a number of advantages that a SRO might have.

Moderator Roye:  Clark, you have experience obviously with SRO, do you want to comment on those advantages and disadvantages and how they might play out in the adviser context.

Ms. Hooper:  Well, if you talk about advantages and disadvantages of a SRO, I really don't know, certainly I can speak to the SRO model for broker/dealers because that's what we are. The only thing I would say is I would like to discuss that model with an eye towards giving you a feel for the expansiveness of what we do and what an enormous undertaking it is because, when you look at the types of things that the NASD regulates for the securities industry.

I mean, as Bob articulated, we are really geared towards a different standard than the antifraud standard. We're looking at standardizing the principles and practices of the industry and promoting high standards of commercial honor, adjusting equitable principles of trade, enforcing fair practice regulations and making sure that our members observe the federal and state securities laws.

We have a variety of functions that we undertake, that spring out of those basic mission or core statements. I mean, we have to process all of the membership applications, individual qualification and testing. We run the CRD program, as has already been mentioned to you. The NASD has around 56 hundred-member firms and over 600 thousand registered reps with those member firms.

So for all of those members and individuals, we're responsible for insuring that they are supervised properly, that they are complying with the conduct rules that we have enforced. We do, in fact, participate readily in rule making and examinations, investigations, enforcement. You can go up to our web site and look at every bit of that. What I'm basically trying to say, this is not something that is a start up program that's to be taken lightly.

So if an SRO for another industry is being contemplated, I think you really have to look at whether or not it will work for that industry. I don't know whether the SRO model would really work for the investment adviser industry. It's just not clear that that would be something that would be effective.

As Bob has said, the NASD was founded to regulate broker/dealers, and that's an industry in which members frequently transact business with each other. Like introducing and clearing brokers. There are mutual beneficial incentives for broker/dealers to regulate themselves in order to preserve efficient and effective securities markets that protect investors and promote orderly trade.

Investment advisers, on the other hand, generally only conduct business with their clients or with broker/dealers that execute trades for their clients. They do not generally conduct business with each other. Therefore, a SRO structure may not work well for advisers since they have different incentives for dealing with each other.

One of the unnamed benefits however, of an SRO is its flexibility and changing as the market place changes and applying its regulations through interpretations and using its rule making process instead of having to amend a federal statute. So there is a certain amount of flexibility in accommodating the changes that are going on in the market place that an SRO is able to provide.

A real downside to an SRO or to establishing one, is the enormous cost, which I think would be a real disincentive to having an SRO. You've mentioned that as well, but I don't think one can overstate what it would cost, not only to start up an organization like this but the cost to the membership of providing. I know that at the NASD, our larger member firms, and I know there's probably one at this table that would agree with me. Our larger member firms subsidize the regulation of the majority of our members who are small broker/dealers because they can't afford to pay for it.

So one would have to ask the question, in all likelihood, if an adviser SRO were created, it most likely would be primarily responsible for regulating smaller advisory firms. Probably those that are registered with the states rather than the SEC and it just seems to me that you are going to be confronting a financial question that is not going to be easily resolvable.

Moderator Roye:  Phyllis, is there a need for SRO in the adviser's area?

Ms. Bernstein:  We have concluded that no SRO is needed. That a SRO is unnecessary and inappropriate for the investment advisory and financial planning community, but there's no evidence of a serious flaw in the present and state structure and it seems to be regulated well. But what is confusing, and I think we've talked about that earlier, is that the marketplace is confused about the definitions. Who is an investment adviser? Who is a broker/dealer and who is a financial planner? For those in the business, when you cross lines, do the functional definitions still work or have they become blurred? As there has been changes in the business, do the definitions still work? There needs to be a consistent, clear bright line that is applied with uniformity and we would recognize that need. Not a need for an SRO but yet a need for clear bright lines that are uniformly applied and would be willing to see a debate as to what the definitions are and who should be regulated and who should not be regulated. But not to say it needs to be a whole new structure in place, but yet who needs to be part and who doesn't of any regulation for investment advising.

Moderator Roye:  David, Roy, a perspective on that issue?

Mr. Diliberto:  Sounds like everybody agrees an SRO is unnecessary Paul.

Moderator Roye:  I wonder Roy, whether or not the SRO is a substitute for a federal or state regulation of financial planners?

Mr. Diliberto:  I concur that we probable don't need a SRO for investment advisers. I think the Act works well, as I said earlier. However, an SRO for financial planners is something that I would support. The problem financial planners have when they're regulated is that the people who are regulating them frankly have very little understanding about what we really do. So we're regulated as investment advisers, which is a part of what we do but there's much more that we do that is not understood. To me it always gets back to the holding out provision.

Now, there was some proposed regulation, proposed laws perhaps back in 1988 but the bottom line it did not work. It was never passed politically. There was a problem because of so many of the larger organizations and larger institutions that didn't support that provision. But I think the public needs to know, if someone holds them out as doing whatever it may be, and financial planning is obviously what we are talking about here, they should know there is an expectation of what they will get when they go to someone who is a financial planner. If that person is basically an insurance agent with one product, they need to know that and that person needs to be regulated and disclose the fact that there are those kinds of conflicts. Right now, they escape that regulation. They're basically regulated by perhaps an insurance department that doesn't look at those kinds of issues.

Ms. Hooper:  If I could add to that. While we've ..

Mr. Skolnik:  I'd like to hop in here if I could. I wasn't quite done before, Paul whenever I talked about the SRO, everybody agrees, and in my statement we talk a lot about NASD and my good friend Clark Hooper and I have had some conversations about this in the past. Our organization is worried about NASD and its role and the noises that it has made over the past several years. I even found one quote from the Wall Street Journal in 1986 that there was a roundtable at the SEC on securities regulation, and the day before the NASD Board got together and unanimously approved an SRO for investment advisers, dually registered investment advisers. I guess there's no surprise then.

Ms. Hooper:  I was there then.

Mr. Skolnik:  Okay, I'm sorry, there's no surprise announcement today. Which we are grateful for Clark.

We are concerned, there has been this steady drum beat and talk about regulatory black holes and the fact that there seem to be these problems. I simply don't see them. If you're talking about the financial planners, maybe that's a different dialogue. I think in the level-playing field as well has been characterized. That the '34 Act regulation is more stringent and more comprehensive than the Advisers Act regulation and I think that's just wrong. I guess that's when I go back to, you look at, we don't have an SRO for federally registered investment advisers, thank God. We don't want one. And we'll fight against one. And we certainly don't want NASDR to be the SRO because that blurs the distinction between broker/dealers and investment advisers even further than it is already. And we continue to believe that there is a core fundamental difference between brokerage activities and investment adviser activities. Yes, there is blurring. Yes, this is 2000 not 1940 anymore. But, there still are, at the core, very fundamental differences between the two industries. An SRO simply is not warranted for the investment adviser industry.

There are no documented cases of persistent frauds and abuses like you have on the broker/dealer side. You don't have the level of inter-connectivity, vis-à-vis, I guess that's the way they say it today, right? Investment advisers usually aren't hooked up the same way that the brokerage industry is, and you don't have these technical issues relating to settlement, execution, reconciliation, all those things on the brokerage side. They just simply don't exist.

So I hope maybe today we can all agree that an SRO is absolutely unwarranted and talk about some of the blurring, the important distinctions. But again, I think that it's very important to understand that it would be highly inappropriate, I'm very glad to hear what Clark had to say about cost, it would be absolutely crazy to impose that type of cost on our industry. Our associations always supported reasonable regulation. We've supported fees at the SEC to fund inspections if that's what we need to do. It's more effective folks. It's more effective to have that direct regulation.

When you look at the results of the Coordination Act, the last three years, it's been an overwhelming success at solving the only problem that has ever been identified and that was inadequate oversight of the profession.

Mr. Plaze:  I would just very quickly add, it sounds like a stake has been put through the heart of an adviser SRO. I do think though that many of those same negatives would apply in the financial planning context as well. It's not clear there is a need for that regulation. It is not clear that the mammoth effort would be worth imposing this kind of regulatory scheme when in fact these folks are frequently regulated by a variety of other regulators, whether it is insurance or adviser or broker/dealer.

To have to pull out the financial planning folks from each of those other regulatory schemes and place them under an SRO I think would be enormously dislocating. If you don't do that and you simply put the SRO on top of the existing scheme then you have the duplicate regulation, the cost that we are all trying to avoid. I think we had best be very careful determining if there really is a sufficient problem here that merits that kind of approach.

Ms. Hooper:  One of the things that this dialogue, I think really points to is just how extremely diverse the investment adviser financial planning industry is. Because, I think it's much easier to draw a bright line between your members David, and broker/dealers and the activities, and see clearly why this Advisers Act is working well for your members. And yet, on the other hand, the real blurring of the lines seems to come with the financial planning industry, and who's doing what to whom. I can understand your concerns and it just shows the wide-spread disparity. The breath of the industry and why it's so difficult to come up with one scheme that fits all and I think that we do want to avoid duplicative regulation but I would go so far as to say that the financial consultants in your firm Paul are dealing with different issues than the financial planners in your association Roy so all of this just adds to the complication I believe of trying to come up with a scheme that makes all of the participants feel like they are being regulated fairly and not onerously and perhaps the NASD should be looking at its own rules to insure that it's not over burdensome.

I think in the long run, we can't lose sight of the ultimate goal, which is, as I said earlier, is to ensure the protection of investors and the integrity of the industry at the same time.

Moderator Roye:  Let's move on. Going back to the structure of the statute. If you look at the investment adviser regime and you look at the requirements in the statute, unlike some of the investment adviser regimes and some countries where you have good character requirements, you can only be an adviser if you're quote fit and proper. You have minimal educational and experience and knowledge requirements. For example, in the state level Brad, you have bonding requirements. You have the new competency exam on the state level. Are these concepts that are needed at the federal level, Brad?

Mr. Skolnik:  I really cannot assess whether federally covered advisers would benefit from net worth or bonding requirements. That's something that I think is often times more appropriate for the smaller investment advisers who are engaged in a retail business.

As far as competency examinations go, I think that is something that professionals at all levels should possibly have to face. Regardless of whether they are in the securities industry, the legal field, or the accountants industry. We've been very pleased with the implementation of the new investment adviser competency exam affective January 1. Prior to that examination, there are really very little, in terms of barriers, to entry into the investment advisory field at least at the retail level. Advisers were required to pass an examination. They tested them on state law but lets face it, it was not a particularly rigorous exam and it really did not test them regarding their knowledge regarding product knowledge, theory and the like.

The implementation, I believe, of the competency exam will go a long ways in ensuring that the advisers to whom millions of small investors entrust the good portion of their life savings, demonstrate, at least, some level of knowledge regarding the field in which they purport to be a professional in. I don't know whether say, a competency examination for individuals who fall under the federal regime would necessarily be advantageous. Certainly, it's something that we feel for those advisers who are engaged in the retail level, providing services that it has been a benefit.

The competency exam has been met with I believe a fairly wide scale success among both consumer groups as well as the industry. It was devised in large part, with a great deal of input in advice from members of the industry, to make sure that it was appropriate.

One issue that we faced from the outset was the fact that it's very difficult to define what an adviser does because there is such an array of differences in terms of services provided even to small retail investors. But, I think the competency exam really is potentially long-term very beneficial for the well being of the investors.

Moderator Roye:  Bob, do you have any reactions? I know you thought some about this issue.

Mr. Plaze:  Yes, I had an occasion to be involved in these issues over the years. Bonding is quite interesting. You know the Commission proposed legislation supported by many areas of the industry a few years ago that would have added a bonding requirement. Advisers are the only financial service industry in the country that I know of that is not subject to some bonding requirement to protect the investor assets. Typically when we see large frauds and we go in to clean up the mess, so to speak, there are not sufficient assets to pay off the clients who have losses as a result. Another area, one you might want to consider bonding for is its another form of self-regulation. There is no organization more interested in protecting its assets than the bonding company or imposing stringent controls on people they bond.

Look at the fraud a number of years ago, Steven Wymer from California. A number of mid-western, western communities lost their savings. University and college systems lost tremendous amounts of money by his fraud. However, note, the ERISA assets under his control that were subject to the bonds, he never touched. So I think there is some learning there and something that might be useful for considering. I think it would have to be a meaningful bonding requirement.

In the competency requirement, I speak for only myself here, I think we have to be careful as government regulators before we pursue this. I think it's a difficult area.

One, when we initiate competency, we prevent people from entering a profession, entering a means of livelihood until we say they are qualified. Until the government says, they are qualified. That's a difficult standard to impose upon people. Particularly in an industry as varied as the advisory industry. From the small financial planner who is giving very simple advisory services, to the community, to the most sophisticated international portfolio manager. How do you devise a set of tests that is meaningful for both, to allow them entry into this field? If you set it too low so that you do not deny services to middle America, because simply the people cannot afford the education, the backgrounds to pass those exams. If you set it too low then are they really competent because they indeed will market that?

Finally, how do you test competency in investment advisory area? I know Brad; you're going to want to respond to this. There are theories of investment advice. One that I like to give, there is this Elliot wave theory you see sometimes in some of these magazines. I know most advisers do not subscribe to that but who are we in the government to say that's a wrong theory of investment advice. That if you checked the box or you're writing an essay that you are not going to be able to give investment advice. I don't think there is any consensus among financial professionals as what is appropriate investment advice.

So one thing possibly to do is well, you simply don't test on investment advice, you test on law and process. Another question is, "Well does the person really know how to give investment advice?" If they are claiming that they are certified to be competent, have we created a greater problem than existed at the beginning?

Those issues concern me. Brad, maybe you would want to talk about how you have thought about these issues and dealt with them in your contact.

Mr. Skolnik:  No, these are issues that the states obviously considered when devising the examination. That's one reason why we work closely with the professional testing service, to make sure that the exam was what we would considered to be a valid one. I don't think it's inappropriate to ask that those folks to whom millions of small investors entrust their life savings to demonstrate some appropriate level of competency or understanding of basic investment principles. We do it with lawyers. We do it with accountants, with physicians and others to whom we entrust important issues in our lives to.

I think the same thing should apply in the investment advisory field. The fact of the matter is, if you deal with an investment adviser or if you receive, advice from someone who is not capable and does not know what they are doing, you can lose your entire life savings. The same way that dealing with an incompetent lawyer or accountant can have devastating consequences for an individual. Certainly there is no exam or test that is going to insure that somebody is ethical and that somebody is going to do a good job. If you think about it, when it comes to the practice of law, the accountant's profession, we do require testing that is very rigorous and does involve some level of competency there. I think it's only appropriate that we demand the same thing of investment professionals.

Mr. Plaze:  I think Brad, for each one of those organizations that do that, there is a self-regulatory organization involved for the medical, legal and other professions rather than government doing it directly. There is also an issue, of course, is raising barriers to entering and keeping prices high.

Mr. Skolnik:  The competency exam has not – the cost of entering the investment advisory field was really not increased at all by the implementation of the competency examination. I will tell you from having to review some of the sample questions myself; it is basic information that I think any investment adviser should have because I was able to answer a surprisingly large number of the questions. I will tell you I'm a lawyer, which qualifies me for probably very little. I'm a lawyer, not an investment professional and I would be very concerned if I went to an investment professional and he or she could not pass that examination.

Moderator Roye:  Let's keep moving. We wanted to discuss NSMIA. I think we are going to move quickly by that one. I think from the SEC perspective we have a sense that NSMIA is working well. I think it's been alluded to. It's allowed us to reduce the inspection cycle from fifteen to twenty years to five years for the federally registered advisers. We have the sense that it is working well on the federal level. Brad, on the state level, any quick reactions?

Mr. Skolnik:  There's still a number of outstanding issues that we have dealt with in terms of implementing the Coordination Act in a uniform manner. I think we have made significant progress in doing that. Equally important, I think for investors, the states have now begun the focus much more heavily on investment adviser's examinations and inspections.

I can speak from personal experience in my home state. Prior to the passage of NSMIA, we did not have any formal examination or inspection program for small investment advisers. After Congress bestowed full responsibility for the registration and oversight of small investors upon us, we implemented an inspection and examination program in my state. In a little over two years now since it has been in place, we have conducted approximately two hundred examinations. Which has resulted in, I believe in only about a hand full of referrals to our enforcement department for further investigation.

Maybe every bit as important however, there has been numerous examinations that have resulted in detection of rather minor compliance issues that we have been able to help the firms resolve through either deficiencies letters or even exit interviews. I think that is an important step we have taken because it allows the firms to nip potential problems in the bud before they escalate or fester. In addition, the industry's responded very favorably to the fact that the state is now out in the field. I think, by and large, they have welcomed our oversight in that area. We try not to be burdensome and I don't think we have. I know in my home state, the fact of the matter is it has resulted in increased oversight in protection for investors.

Mr. Tittsworth:  Paul, I know you want to move on, but I can't resist another opportunity to barge in here. I don't think very many people; probably the people in this room do recognize what impact the Coordination Act had. It's a grand experiment in federalism. You had this problem. You had all these registered investment advisers, 23 thousand of them, in 1996, a growing industry, managing trillions of dollars in investor assets. Typically or historically, our profession has been dually regulated by both the states that were there first starting in 1919 in my home state of Kansas and the fed.'s who popped in 1940. You had this system where both of them were out there regulating the same profession, there were problems, there were costs, and there were inefficiencies. We talked about the SRO proposed legislation. There were other proposals in the early '90's that would have imposed fees on federally registered investment advisers to give this Commission more resources. None of those bills made it through but in 1996, the Coordination Act was passed and by this division or allocation of regulatory responsibility, Congress solved a hell of a big problem. It has been very successful.

On the state side, from our federally registered adviser point of view, we definitely commend our friends at NASAA. I won't go into detail. We think there are some problems, referring to the state of Texas. That is a very unfortunate as part of the promise of the Coordination Act, was uniformity, getting rid of this state regulation that was unnecessary and it's still not uniform. My former boss John Dingle used to have an expression about herding minnows and I'm sure that's Brad's dilemma. It's a constant problem.

By and large, on the state side, it's been successful. On the federal side, Paul, I guess you give yourselves an "A" plus. You look at the regulatory side. You have the creation, the investment adviser task force in 1997. It's in the process of reviewing every regulation on the books concerning investment advisers. I put in my statement, all the rules that have already come out. The damn rules you've got that are pending. The ones that are coming up. This is a revolution folks; this isn't just that Congress passes a law and something sort of changes a little bit. This is a full-scale revolution in adviser regulation.

Moderator Roye:  Thanks, David.

Mr. Tittsworth:  I don't know whether I should be thanking you or not. On the inspection side, my good friend Gene Gohlke sitting here. The inspection cycles have gone from once every thirty years, fifteen years, forty-four years, pick it. To once every five years, more sweeps. It's an unbelievable story. Enforcement, the numbers are --.

Ms. Medero:  Some of us traveled a little farther than you did that maybe would like the chance to speak. Thank you.

Mr. Tittsworth:  Sure, Sorry.

Moderator Roye:  Let's move on to some of the exclusions in the statute. One of the ones that's been a focus recently is the broker/dealer exclusion where brokers are obviously engaged in re-pricing their services, charging asset based fees, execution only services, side by side, full service, brokered services. We have a rule proposal pending that goes to that issue. Let me start with Paul. What's happening in the broker/dealer community, Paul, that raises these issues?

Mr. Gottlieb:  Well, obviously a lot has been happening and the asset based pricing alternative that all the firms have come out with over the last couple of years has really been the focus of a lot of comment and is in the process of changing the industry pretty significantly in terms of giving clients a choice and how they pay us. Do they want to pay us on the basis of assets or do they want to pay us in the traditional commission based model.

We think that this new pricing is a pretty startling development and a pretty beneficial one as far as our clients are concerned. Obviously, clients have agreed to the extent that they are literally flocking to these new alternatives. There has been a lot of confusion as well and we're really only talking about a pricing alternative here. Just briefly, one of the benefits of this kind of alternative, well first off you're giving customers a choice. We believe choice is basically always good. It offers clients a chance for better predictability of their costs and that seems like a pretty beneficial thing. It can significantly reduce costs for clients who want to trade frequently and that seems like a pretty beneficial event.

Most importantly from our perspective, this type of pricing moves us away from the traditional commission based concerns that clients have had, that compensation is tied to particular trade and in doing so, in aligning client interest and firm compensation in a better way, we're moving towards the recommendations that were made by the Tully Commission's Report and really trying to minimize those conflict of interests concerns that have bedeviled the brokerage industry for a fairly significant period of time. So what we're doing here is offering the same services. Really the same traditional services but with a new pricing alternative. We should be clear because the advice word, the "a" word is used.

Traditional brokerage service, traditional full service brokerage service includes advice. It's incidental to the trade but the advice is definitely there. Congress recognized this when the securities laws were passed; the SEC has recognized this. Advice has been with the brokerage industry since the beginning of the brokerage industry. We don't think that there is anything to apologize for with regard to that. I have a quote here from the Tully Commission Report that I thought was worth mentioning. "The most important roll of the registered representative is after all to provide investment counsel to individual clients." We think that's true. So we take these words seriously. We provide them. Clients now have the choice of commission based services, or asset based services, nonetheless we think this is all a positive development. Needless to say, we support the adoption of the rule.

Moderator Roye:  Roy is the issue special compensation or is it really that advice is no longer incidental?

Mr. Diliberto:  It's actually both in my opinion. As I was listening to Paul, I thought about my own personal situation when I was earning commissions only and not fees and I gave advice and obviously I wasn't registered. When I decided that I needed to charge fees, I didn't ask for an exception, I got registered because that's what I needed to do.

There is a major difference here and the advice, whether it is incidental or not, and I don't think it's incidental because Paul said it wasn't. He said many of his brokers provide financial planning services and I commend it. I agree that what they are doing is extremely positive. When a customer goes to a full service broker and the customer understands that the compensation will be transaction based. The customer puts up some antenna to judge the advice. In the context, that that customer knows that there is inherent conflict of interest between that customer's interest and the interest of the broker. The customer knows that. It's implicit in the relationship and the transaction is what drives it and there may be some advice and maybe that is incidental.

However, a customer's level of expectation increases significantly, and I can tell you that from personal experience, when you're charging a fee, they fully expect objectivity and as a result, I believe you now become a fiduciary. You're a fiduciary under the Act; you're not necessarily a fiduciary under the NASD regulation. So it's that fiduciary relationship and it's the disclosure of all conflicts of interest that the consumer needs to be provided with.

So it's a question of a level playing field. I don't see any difference in what the major brokerage firms are doing and what investment advisers, if you will, did in the early '80's when they decided to go into the fee business. They registered. To have a level playing field my question would clearly be as a financial planner who provides asset based fees, why would I not be excepted from the Act when, in fact, functionally we are doing the same thing.

Mr. Gottlieb:  I guess we think there's a pretty clear line of distinction here. When you're providing brokerage services I think it's pretty clear on its face what it is and I have to smile here a little bit because it's a little bit damned if you do and damned if you don't. When the industry was entirely commissioned based, there was criticism. How can you have a system that compensates you for doing a trade? Maybe a trade is not always the best thing to do. Now that we're going to a system that your not tying compensation into the trade, you're getting criticism from the other side. How can you possibly give advice when maybe you don't do a trade? Well, maybe the point is we should not have a theoretical argument about it.

Clients, pretty clearly I think, understand this service because it is held out as a brokerage service and if the SEC rule is adopted it will state that advisements specify it as a brokerage service. We use a client agreement that says it's a brokerage service. In fact, the trading function continues to be the hallmark of what is being provided here.

I really think it is pretty clearly, excuse me for repeating myself again, pretty clearly brokerage and that clients understand it. Now your getting away from the tyranny of commissions and giving customers a chance to feel that they're on the same side of the table as their broker. That alignment is I think something that we should applaud. Something that was in line with the Tully Commission Report and one that really doesn't raise great theoretical issues since we still have a frame work that talks about services being provided incidental to a trade.

Mr. Diliberto:  All you need to do is watch television and look at the ads. Look at some of the full-page ads that are run in the newspapers almost every day of the week and see what is being promoted. Advice is being promoted and by the way, I don't quarrel. I absolutely totally agree that this is a positive thing for all consumers. I just have a question that I don't understand. I don't understand why the exception is necessary. My question is if functionally this is what you're doing, then what is it about what your doing that you don't want to be part of the Act and the fiduciary relationship that you say you have with your client, being on the same side of the table. That sounds like fiduciary to me and why wouldn't you want to adhere to the disclosure requirements and the antifraud provisions of he Act. What is wrong with registering? I don't have a quarrel with you doing it, I think it's wonderful. I have a quarrel with you not being registered while your doing it.

Mr. Plaze:  If I could respond. I don't register so I could do so. I'm a big fan of the Advisers Act. Most of my career has been spent working with this statute and I'm a true believer in what it does. At the same time, I have to recognize that the Advisers Act was passed six years after the Exchange Act. It was written to regulate broker/dealers and from the get-go the authors of the statute, the Commission, recognized that investment advice was an intricate element of brokerage services, and the Act was not intended to be an overlay of broker/dealer regulation. It was intended primarily to pick up a group of individuals giving investment advice that was not subject to Commission regulation at all. So therefore, it creates an exception for broker/dealers who provide services that are incidental and then receive no special compensation.

My view of the primary condition is the incidental, the special compensation. The brokerage commission is what they were looking at in the 1940's; well what did brokers do in 1940? How are they compensated and special compensation was thought of something besides the fixed commissions that brokers were receiving at that time.

Let's hyperlink, shall we say, up to 1999 when the broker services started to be re-priced. Finally eliminating the primary source of conflict of interest that has resulted in a phenomenal percentage of enforcement cases the Commission has brought over the last fifty or sixty years as well as the other problems that we have seen in the industry.

There's conflict. They achieve this after the Tully Report and then the first thing what's going to happen is their going to have applied to them the Advisers Act which is specifically intended to deal with conflicts of interest. So just when they've eliminated the principal conflict of interest, the operation of the statute designed sixty years ago is going to apply on another scheme of regulation on top of them that's going to not supplant broker/dealer regulation, but it's going to be an additional overlay of regulation. To some extent the overall issues of public policy here, it seems to me that, the elimination of commissions that the industry has been tethered to since many years as Paul spoke of has more positive investor benefit protections than any statutory scheme we could ever devise. Because it is the system is of incentives and pay incentives that drives how people behave in this industry.

The criticisms that this is not exactly a bright line or not completely a functional test, I plead guilty. Because, I don't think it is possible in this area of broker/dealer advisers divide a bright line and have all advice governed here and all broker serviced here. They're inextricably linked in a broker/dealer. The question is where do we draw an administrable rough line, rough justice, governing. Who shall be governed by the broker/dealer regulations? You're subject to fraud, intend be, a whole host of regulations related to that and who should be regulated just under the Advisers Act. It's not easy to do.

Mr. Gottlieb:  I guess I would add that it's not a matter of being afraid to register. In fact, every major brokerage firm is already dually registered as a broker/dealer and an investment adviser. Speaking for my firm, we have more assets under management as an adviser than we have in the fee based programs at this point where we're entirely comfortable with the rules and regulations and the disclosures et cetera.

In the brokerage industry, we are now seeing a significant transformation in terms of how customers can compensate their brokers. We think this doesn't raise, as Bob said, this puts aside some of the conflicts that have existed in the past. There is simply no reason to consider that function, which continues to be brokerage and which, is truly held out as brokerage. There simply is no reason to put it under the overlay of the Advisers Act.

Moderator Roye:  We want to move on to some of the other exclusions, particularly the bank exclusion and the accountant's exclusion in the statute. The Graham Leach legislation has really narrowed the bank exception. Those banks that advise investment companies have to register now. Joanne, how will banks operate? How will they register? What bank itself will register? Will they register separately identifiable divisions? How will the operations of the bank be affected as a result of this?

Ms. Medero:  I think as they, at least as they taught in my law school, the best answers to those questions are, it depends. I think a lot depends on the current situation a bank is currently in. A number of them, as the Commission is aware, already have separately created investment advisory subs that advise mutual funds. A number of banks do not and I think a lot of it will depend on what kind of color the SEC puts around what is a separately identifiable department.

There are advantages to the push-out provisions. A separately created entity could permit a bank for example to provide more flexibility on how it compensates its portfolio managers. It may aid retention. It may make the business more transparent to analysts. Traditionally, people have thought that the steady stream of income from investment advisory worked where mutual funds is a positive to your stock price and you would have advantages of having one regulator, that's assuming your over 25 million in management.

The disadvantages, I think, are the costs. There are push-out costs that are one time, creating the subsidiary, soliciting proxies for a change of adviser. Then there are continuing costs in maintaining a separate corporation. There may be duplication, loss of synergies between the bank and its subsidiary and monitoring and establishing service arrangements to assure that you do get the investor protection that we all seek. So I think it will depend I think, and frankly the sooner the Commission does provide some direction as to what it would consider to be the separate identifiable department, working of course with bank regulators. I think it will put the industry in a position where it can evaluate these various pros and cons and move forward.

Mr. Plaze:  Do you think that banks will create the "SIDDs" or will they drop things down into subsidiaries or register the entire bank under the Act. What's your expectation?

Ms. Medero:  I think – well, some people will put the subsidiary off the bank holding company, is that what you're asking? Some will put it underneath the bank. Right now in our situation, it happens to be for historical reasons underneath the bank. I think there is a concern by particularly large commercial banks that to register the entire bank as an investment adviser may provide an opportunity for the SEC to go beyond its investment advisory typical exam. Therefore, I think that's one reason why people sought the separately identifiable department, which is actually, where the investment advisory work for the mutual funds would be occurring.

Moderator Roye:  So you don't see, in terms of splitting off the investment company advisory operations, you don't see other bank advisory operations in that unit necessarily because of the concern that the SEC may be looking at more than what it --

Ms. Medero:  No, I'm actually thinking is whether or not it gives a more of a car wash into other activities of the bank, and rather than the investment advisory activities that may be conducted, let's say, in the trust department for separate accounts or individuals.

Mr. Plaze:  Part of the problem and this "SIDD" development is not, I guess a wholly satisfactory resolution or at least from our perspective. One of the things that we look for in an exam, a mutual fund exam, is to determine whether there is trade allocation that disadvantages the investment company clients. Let's say the bank does a trade and allocates parts of it to its private clients, its trust accounts, its collective funds and part to the investment company. We would obviously like an opportunity to see whether that allocation was fair. Whether the investment company clients were not disadvantaged and the current scheme simply does not allow that area of examination for us.

Moderator Roye:  Does anybody else have a perspective on the way the bank exclusion works today, in terms of a level playing field type issues?

Mr. Diliberto:  That's obviously the theme of what I have been saying. That whoever is in the business and is functionally doing investment advice needs to be regulated on an equal basis so we're just looking for a level playing field. I believe that at some point solely incidental needs to be defined.

Ms. Medero:  I actually think the playing field is more level than perhaps banks are given credit for. There is a shared core principles for bank fiduciaries that is invited also in the Advisers Act which is the avoidance of conflict of interest and self-dealing. There is supervision by either state or national bank regulators and the common law of fiduciaries and trust. I think banks may get there a different way but I think if the goal of regulation is customer protection, I think it is achieved without an overlay of the Advisers Act.

Moderator Roye:  But Joanne, do you think that giving the bank regulators primary mission, which is the promoting the safety and soundness of the bank. In other words, the investment adviser regime has sort of a different thrust and purpose. Are the bank regulators going to be effective applying those kinds of standards when there's a problem within some of the advisory functions?

Ms. Medero:  Well, a few years ago the bank regulators moved to a concept of supervision by risk and particularly for an institution that is principally a trust bank or where a lot of its income comes from that activity. Reputational risk is one of the issues that the bank examiners look at and how one handles fiduciary issues. In the event of a conflict with a client and how you manage, that I think is something that is looked at by bank examiners. Maybe a few years ago, less so, but I know from our own experience that those type of issues are part of the bank examination and it is not just the safety and soundness of the bank or the banking system can be affected very much by a large reputational event affecting the bank. I think we are examined with a customer perspective because of that.

Mr. Gottlieb:  Paul, we also look at banks as providing banking services and therefore appropriately monitored and supervised by banking regulators. That's one reason why one of the dichotomies under the Advisers Act that we would like to see fixed is the dichotomy with regard to thrifts and how thrifts are regulated. Given the changes that Graham Leach has brought us, we think it is time for the staff to think about whether thrifts should be considered banks for the exclusion. Given the fact the many are in fact providing very traditional banking services, similar to national banks, that they're under the supervision of the OTS and FDIC which is providing rigorous, to say the least, regulatory review. We think it really is time that they be recognized as banks on their face.

Moderator Roye:  Of course the Congress just visited this issue and did not extend definition to ---

Ms. Medero:  I understand it's up again.

Moderator Roye:  Let's move to the accountant's exception. Phyllis, there are a number of your members who are relying on the accountants exclusion, a number of your members who actually do register as investment advisers. Any trends in that area, any problems with the accountant's exclusion from your perspective?

Ms. Bernstein:  Well, I think it's important to note that sixty years ago accountants did not receive compensation in the form of commissions or referral fees or contingent fees. Today in some states they can, actually in forty states, they can. The practice of accountancy is changing for those CPA's who are providing services in advisory area in tax planning, in estate planning, in non-attest functions. They can receive with disclosure to their clients new fee sources that they never were able to receive before. By "commission" in accountant's language, they're talking about a fee paid by a third party and not by the client which is new for CPA's. Back in the beginning, in 1940, CPA's were only paid by clients for giving advice for providing services to the client. Today that is different. CPA's can be paid by third parties. They're required to disclose that. They are not permitted to do that for attest clients. Attest meaning audit review and compilation. So things have changed in the accounting profession. What are the natures of services that a CPA is providing? When have they crossed the line to be in this new world of investment advice or in the world of being subject to representative of broker/dealer firms? It's a question that comes up. It's a new service for many of our members and many of them have become investment advisers and registered reps.

There still are significant numbers of members of our profession who will be doing, and will continue to do, traditional services, attest function, audit review and compilation of financial statements, providing insurance to third parties that the financial statements fairly present generally accepted accounting principles. That's what the profession does primarily and the financial planning, the tax planning and the estate planning are services that are beyond that, and those services are traditional services as well. Both a part of the scope of what the practice of public accountancy is all about. That's part of what state boards regulate. When you hold out as a CPA, and you do a state planning and financial planning and tax planning those services are regulated. So for that same client that you do estate planning for, if you also do an audit of those financial statements you would be precluded from receiving a commission. A fee paid by a third party. Therefore, our profession will not wholesale become a registered investment adviser. Therefore, our profession will not therefore all wholesale become registered reps of brokerage firms. There are reasons they are prohibited and really, it has to do with third party assurance to the financial statement. How could you attest to the financial statement to the fairness if you've recommended their products? How could you attest to the fairness of value if you've sold that product? These are subjects that are prohibited.

By and large, more of our members are getting involved in advice and probably should be extending their relationships with their clients to be more involved in advice. But yet at the same time when they are involved in third party attest services, which significant numbers of our profession do that, they will not be involved in the practice of investment advising.

When they give advice about investments and they receive fees for that, either contingent fees based on assets or fees from third parties. Today, you see many CPA firms setting up entities and registering. And you see many CPA's individually becoming representatives of federal investment advisers or state investment advisers. So CPA's by and large understand that when they're in the business of giving investment advice and that getting paid for that, they should register.

It's just a question of the word "commission". How does the word commission translate in accounting terms versus how it translates in securities terms. CPA today hears the word commission and says the word commission, they're talking about a payment they receive from a third party for recommending services of a third party or products of a third party. So in other words it's not paid by the client. It's paid by a third party.

Many times we see in our profession CPA's talking to other financial service providers saying they would liked to get paid commissions and they really are hearing it and the other parties hearing the word commission and hearing that word they're saying well you need to get a license to sell products and really what the CPA is looking for is a referral fee for referring that client to adviser not necessarily to be selling products but really to give advice about another adviser. To get paid for the referral of another adviser. What you might call an introduction fee or a solicitation fee.

So there is some, we'll call it language barrier, between CPA's when they use the word commission and the financial services industry, when they use the word commission and I think there needs to be some clarity into that issue to help our members understand that there are different meanings to that term.

Moderator Roye:  I guess Phyllis, you focus on the notion of commissions and I think from an SEC perspective we view those commissions as compensation no matter what the source from the stand point of the definition of what an investment adviser is. I guess, at least in my mind, it would come down to a question whether or not your members are giving advice with regard to the value or investing in securities. In the business of doing that that wouldn't make them an investment adviser.

Ms. Hooper:  One of the things that our board has strongly urged us to do, is come back to you all Paul, and ask you to look at the term commission and give some more clarity to it. Because, there are a number of payments today that seem to be for payments for sale of securities that could trigger broker/dealer registration. Like the receipt of 12(b)(1) fees. We really would encourage you all to take a look at the word because it seems to be generating as much confusion in other areas as in our own. And see if we cannot make some distinctions as to what you really are using the word "commission" for in terms of, for example, an exemption from registration as an adviser as opposed to whether or not the term should encompass something that would require registration as a broker/dealer.

Moderator Roye:  We've gone a little bit over our time. We wanted to cover the publisher's exclusion particularly in view of what's happening on the internet and the uses there. I think we're going to defer that. We have a panel this afternoon that focuses on technology and internet issues and they'll get into a discussion hopefully of the publisher's exclusion.

I would like to thank our panelists. I think there was an interesting discussion of some things for us to think about. We will start our next panel promptly at 11:15 on trading practices. Thank you.

(A brief recess was taken.)

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Moderator Fornelli:  Thank you Paul. I'm honored to introduce all of you today to our illustrious panel of experts that we have assembled. Although I'm sure most of them are well known to all of you. To my immediate left is Paul Haaga. Paul is the Executive Vice President and Director of Capital Research and Management Company as well as Chairman of Capital Research's Executive Committee. He is the Director of a number of mutual funds managed by Cap Research as well as a member of the Executive Committee of the Board of Governors of the Investment Company Institute. Additionally, he is Chairman of the Investment Companies Committee of NASDR and of course, we're proud to claim him as a former member of the SEC staff.

To Paul's left is Henry Hopkins who is a managing director, member of the Board of Directors and Chief Legal Counsel for T. Rowe Price Associates in Baltimore. Henry is Chairman of his firm's ethics committee, a member of the equity fixed income and municipal bond brokerage control committees and serves as Vice President of all of T. Rowe Prices' funds. Outside of T. Rowe Price he serves as the Chairman of ICI SEC Rules Committee and is Chairman of the Board of ICI Mutual Insurance Company.

Next to Henry is Tom Lemke who is a partner in the Washington DC office of Morgan, Lewis & Bockius where he concentrates on investment management matters. He started his career here at the SEC in the division of investment management serving as Chief Counsel during his last three years of his tenure. Prior to joining Morgan, Lewis, Tom was a General Counsel and the Chief Operating Officer of a mutual fund company. He is a frequent speaker on investment management issues and has co-authored a number of books in the area including the seminal Regulation of Investment Advisers and Soft Dollars and Other Brokerage Arrangements.

Rounding out our industry panelist is Chuck Tschampion, who is sitting next to Tom. Chuck is Managing Director of Investment Strategy and Defined Contributions Plans at General Motors Investment Management Corporation. Outside of GM, he is Chair of the Board of Governors of the Association of Investment Management and Research, or as we commonly call it, AIMR. Chuck has been actively involved in AIMR standard setting in the areas of performance presentation, soft dollars and personal investing.

Last, but not least, at the end of our panel is Gene Gohlke, an Associate Director for Investment Company and Adviser's Compliance in the SEC Office of Compliance, Inspections and Examinations. In this position, Gene is officially responsible for managing the Commission's program for the examination of registered investment companies and investment advisers. Unofficially, he is of valuable assistance to us in the Division of Investment Management.

I'd like to point out that several of our panelists have submitted materials. They're in your notebooks and, in Gene's case, they're available out on the table. So I would invite all of you at your leisure to review those and with that, I think, we will turn to our first topic.

We have quite a number of topics to discuss today; in fact, I'm not sure that we will get to the last two, which is custody, and trade correction, but we will try. But, we want to start our first panel discussion with best execution and the use of soft dollars. Specifically what is an adviser's obligation when seeking to obtain best execution and when using soft dollars?

The Commission recently in the last few years has launched three major initiatives in this area. As all of you know OCIE conducted sweep exams and issued a report on soft dollars.

The Division of Market Regulation currently is working on an update to the 1986 28(e) release, which they're consulting with both OCIE and the Division of Investment Management on.

Then finally, OCIE, also in coordination with the Division of Investment Management and the Division of Market Regulation, is conducting best execution sweep exams. Although that effort is much more of a fact gathering effort and I think they are just winding down their fact gathering and have yet to reach any conclusions in that effort.

So those three things are currently going on and with that backdrop I would like to begin our discussion by asking each of our industry panelists in one sentence to please define what each of you think best execution is. I am going to start with you Paul.

Mr. Haaga:  $.06 a share. Mike Eisenberg jumped out of his seat when I said that. Can I have one more sentence?

Moderator Fornelli:  Yes.

Mr. Haaga:  Same brokers, same cost, as you would have used if there were no conflicts of interest.

Moderator Fornelli:  Henry.

Mr. Hopkins:  Combination of price, commission, time and size.

Moderator Fornelli:  Tom

Mr. Lemke:  I think it's the adviser's duty to seek the best net price for the client under the circumstances and in light of the conflicts of interest that the adviser has.

Mr. Tschampion:  I think it's very hard to define what it is. One thing that I would want to point out that it isn't, is that best execution is not necessarily good execution, nor is the obligation to get best execution, it is to seek it.

Moderator Fornelli:  Gene do you have anything you want to add to the definition?

Mr. Gohlke:  I could add one. It's a little different, actually it's the same I think but said in different ways. Placing trades in ways that are intended to capture for clients the maximum value of the investment ideas, giving due regard to the circumstances in which the trade is placed. This, I think, goes back and looks at the investment advisory firm as in business to produce investment performance.

Obviously, there are transaction costs in putting investment ideas into client's portfolios so the idea is to get those investment ideas into client portfolios and capture the maximum amount of the value of those ideas. But there are costs obviously in effecting those transactions and the ideas to minimize those costs but recognize the circumstances that surround how those trades are being placed.

Moderator Fornelli:  Well a number of you mentioned costs as a factor in considering best execution. Paul jokingly mentioned $.06 a share, but what are the other costs? What are other transaction costs that are associated with best execution besides just the transaction compensation? Are there other ways to quantify costs or other things to consider in that?

Mr. Haaga:  If you ask our traders, one of the biggest factors that they consider in dealing with brokers is confidentiality. There are some firms that you use and somehow the word seems to get around that you have a big trade working and there are others where you don't and that dwarfs cost. I joke about $.06 a share. I think I would be more worried if I find out that an adviser was executing trades for $.00 a share because I would know there was some other way of getting compensated. I would have no way of telling how it was.

Moderator Fornelli:  Any other costs that you all deal with?

Mr. Tschampion:  There is sort of a whole iceberg of transaction costs of which the commission cost is naturally the most obvious but also possibly the smallest one that you have to worry about because it is so transparent. Things like the market spread in seeking best execution, the ability of the broker that you use, to be able to get inside that spread and make it as narrow as possible.

There is the issue of market impact of which confidentiality with the broker is a key aspect of making sure that you minimize that, but there are a whole host of other factors that get into it in terms of the liquidity of the issue, the ability of the agent that you are using to commit capital if necessary to ease the cost of getting that transaction to take place in the market. These can add up to be really the seventy-five or eighty percent of the cost of the transaction and all of these have to be taken into account in my mind in seeking best execution.

Mr. Hopkins:  Confidentiality, we think, is a very important issue. Occasionally we're disturbed that there appear to be breaches in confidentiality of our trades. Looking at the broker/dealer rules, there really does not appear, at least we could not find any specific rule, which established a requirement of confidentiality on the part of the broker. Something to think about. MR. LEMKE: Cindy, one other thing I'd throw in is that transaction costs are a short-term element, but there is also the longer term element of an adviser's trading pattern with brokers. And it's quite common that advisers want to have good relations with broker/dealers for the long term.

Because while they do want to get the best on this particular trade, there are also situations where they may, in the future, need the broker to do something in addition to a typical transaction. So you want to build up good will and long term costs into the trading patterns.

Moderator Fornelli:  I suppose that's the difference than when your setting up a brokerage relationship, in trying to set up these various programs, than issues that might come into consideration on the trading desk. Are there tensions at different levels within a firm with seeking to get best execution?

Mr. Gohlke:  Perhaps, could I say it in maybe a little bit different way. Are there considerations going to best execution at perhaps two different levels within a firm? Think of the trading desk level where an order has come. On the front of the portfolio manager, buy 250 thousand shares of "x". What is the primary focus of the trader on the desk that is trying to execute that trade?

Mr. Haaga:  The focus – first of all on Tom's point, it's a good one. It's a long-term relationship. You can't pick the broker based on how they would have done on that trade because you don't yet know. You pick them based on how they have done in previous trades, kind of obvious but worth remembering.

In terms of consideration, the portfolio counselors are evaluated and paid according to the investment results in their accounts. So when they decide that they want to get a security and they want to get it at a particular price or at a particular time. If they give some discretion, and different portfolio of managers will work differently on different trades, they want the trade to happen and they don't have any individual incentive in creating any rewards for research or for sales. They want things to happen and I think that's what you were getting at, that it's that kind of incentive that I think helps mitigate the conflicts within the organization.

You've got a group of people who are, and by the way, they're the people who evaluate the traders for their annual review and annual bonus. They are very, very personally interested in getting the securities they want, when they want them and at the price they want.

Mr. Gohlke:  So at the trading desk level, at least from what I've heard in talking to traders, is that liquidity or looking for liquidity is terribly important, at least for larger trades. Trying to find liquidity at the lowest possible cost. I would say that's what the trading desk is about.

Mr. Tschampion:  Maybe a little bit more theoretically that the cost is sometimes gauged in terms of time as opposed to dollars. I think traders can be viewed as people who try to buy time economically for their order initiators, the portfolio managers. If they are subject to a price constraint, as opposed to a time constraint, they may have much more latitude in reducing a lot of those market related costs. On the other hand, if the portfolio manager says I have to have the security now because I feel I have information that is important, then they may very well have to pay up, if you will, into the market place in order to get that in the portfolio. But, in either case you're serving the interest of the client to the trading desk.

Mr. Hopkins:  In evaluating and monitoring best execution on our trade desks, it's really from a lot of different sources.

Number one, our clients, many of our clients, monitor our execution skills and abilities. The portfolio managers monitor very closely the effectiveness of each trader that is assigned to their account.

In addition, at Price we have an equity brokerage control committee which was mentioned earlier, which I've been on for quite a few years, that committee not only oversees soft dollar allocations but they also oversee the entire process of the trading function including best execution. The boards of our funds review best execution and most recently, we hired an outside expert to come in and independently evaluate overall the effectiveness and the best execution capabilities of our trading desk, to really get a totally independent third party to evaluate the efficiencies of our trading process.

A lot of scrutiny has been given to the trading process, some people feel maybe too much. We think that in today's environment it is necessary.

Mr. Haaga:  We talk a lot about measuring best execution and having consultants come in and look at the average trade price for the day and things like that. There is sort of two parts you can look at. You can look at best execution or you can look at the other end, which is what are the distractions. Best execution, it seems to me because it's so hard to prove, it's one of those things where whoever has the burden of proof loses in the case.

I said to our mutual funds boards, one of our jobs as fund officers is to select custodians for the funds and to negotiate those fees and the amounts paid to the custodians are fairly substantial, but I have never been to a conference on the topic of best custodian. No one ever talks about best custodian selection. The reason is there aren't conflicts.

When we tend to address this with the boards, we tend to talk about okay; you cannot prove that you got the best execution. Let's go to the other end of the issue, talk about the conflicts, and tell you how we deal with the conflicts and how we minimize them. That's issues like not making specific comments, not communicating to brokers, what the sales targets are and I think most importantly, having a very small percentage of your total trading dollars that are in any way targeted toward anything so that most of your trades are being placed without regard to whether you need to reward anybody.

Mr. Lemke:  Cindy, getting back to your question. I think what Paul was just saying was that, the way typical advisers are set up – the traders, I think their job is to focus on the mechanics of execution. They're generally not the ones making the decisions on the conflicts. That's typically done some place else and then the order goes to the trader to say, "Execute as best you can." Maybe in light of certain factors, given conflicts that may have been considered by the traders; I think what I have seen the pattern is, their job is simply to go out and find the best price, best market, best way to execute the trade.

Mr. Tschampion:  Maybe to bill the cat on this issue a little bit more directly, when we consider our soft dollar budget it is done in a very ex fashion. We happen to make very little use of third party research but we do value a lot a brokerage input in terms of their own proprietary research throughout our firm. We're not a largely staffed internal organization, when we talked about in-house management of the GM pension funds, so we sort of have to rely on street research a lot more than others that are in the business might. We still tried to spread it out and have it be a factor where the trading room is not on any individual trade or even over the course of a month or a quarter constrained in their ability to seek best execution on behalf of the client which is the GM pension funds and so we're able to take that conflict out of their day-to-day operation. They are very much as Paul said trying to keep the portfolio managers happy in the context of getting the best price for that portfolio manager. I think it's important that you have something like that when your dealing with the aspect of using brokerage credits to generate distractions, if you will, to the seeking of best execution.

Moderator Fornelli:  We're going to have to move on to our next topic soon, but before we do I do want to ask this specific question about soft dollars which is, whether or not client referrals in exchange for brokerage should be considered in the definition of soft dollars? If each of you could speak to that briefly, I'd appreciate it.

Mr. Haaga:  We just manage mutual funds so it's a little bit, I can take the liberty of announcing the rule for everybody else here. It seems to me that that would be the kind of thing that would be the equivalent of directed brokerage. If the client himself would agree that it would be disclosed to the client and the client would agree. So I'd put that more in the directed brokerage camp than the soft dollar camp.

On the other hand, that's the kind of thing you wouldn't want to necessarily have a rule that outlawed it because then if you accidentally for some other reason use somebody who referred you, you'd put yourself in a problem.

Mr. Hopkins:  I'd agree with Paul. I think the important thing is, that all these types of challenges are either the responsibility of a central committee that is composed of more than one person so that you have the balance and checks and balances. I cannot more highly recommend the utility and value of such a committee to provide a real oversight on the brokerage practices of your firm's trading.

Mr. Lemke:  I don't think I would put it in the category with soft dollars because, at least the way the law is now, it's an after the fact decision. If you achieve best execution and your doing the best for your clients, it's a tie-breaking factor that you can use and I think that has worked fairly well.

Mr. Tschampion:  We have not had to confront it in my day job. I believe the soft dollar standards of AIMR do address this issue and I believe they encourage not doing it. I don't think, Mike correct me if I am wrong, I think it's a recommendation as opposed to a absolute – you should not do it as opposed to, you cannot do it, in order to be in compliance with the soft dollar standards.

Moderator Fornelli:  Gene, are there any other questions on soft dollars or best execution that you would like to