Certain Broker-Dealers Deemed Not To Be Investment Advisers
SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 275 and 279
[Release Nos. 34-42099; IA-1845; File No. S7-25-99]
Certain Broker-Dealers Deemed Not To Be Investment Advisers
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rule.
SUMMARY: Broker-dealers have begun offering their customers full
service brokerage (including advice) for an asset-based fee instead of
traditional commissions, mark-ups, and mark-downs. Some full service
broker-dealers have also begun offering electronic trading for reduced brokerage
commissions. The Commission is publishing for comment a new rule under the
Investment Advisers Act of 1940 (Advisers Act) that would address the
application of the Advisers Act to brokers offering these programs. The new rule
would keep broker-dealers from being subject to the Advisers Act solely as a
result of re-pricing their services.
DATES: Comments must be received on or before January 14, 2000.
ADDRESSES: Comments should be submitted in triplicate to Jonathan G.
Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street, N.W.,
Washington, D.C. 20549-0609. Comments may also be submitted electronically at
the following E-mail address: firstname.lastname@example.org. All comment letters should
refer to File No. S7-25-99; this File number should be included on the subject
line if E-mail is used. Comment letters will be available for public inspection
and copying in the Commission's Public Reference Room, 450 Fifth Street, N.W.,
Washington, D.C. 20549. Electronically submitted comment letters also will be
posted on the Commission's Internet web site (http://www.sec.gov).
FOR FURTHER INFORMATION CONTACT: Cynthia M. Fornelli, Attorney Fellow,
Division of Investment Management, (202) 942-0720, or J. David Fielder, Senior
Counsel, Task Force on Investment Adviser Regulation, Division of Investment
Management, (202) 942-0530, email@example.com, at Securities and Exchange
Commission, 450 Fifth Street, N.W., Washington, D.C. 20549-0506.
SUPPLEMENTARY INFORMATION: The Commission is requesting public comment
on proposed rule 202(a)(11)-1 and a proposed amendment to the instructions for
Schedule I of Form ADV [17 CFR 279.1], both under the Investment Advisers Act of
1940 [15 U.S.C. 80b] ("Advisers Act" or "Act").
Table of Contents
Broker-Dealers Deemed Not To Be Investment
Fee-Based Brokerage Programs
Execution-Only Brokerage Programs
Scope of Broker-Dealer Exception
III. General Request for Comment
IV. Paperwork Reduction Act
V. Cost-Benefit Analysis
VI. Inital Regulatory Flexibility Analysis
VII. Statuory Authority
Text of Proposed rule
Broker-dealers recently have begun to give their customers the option of
paying for brokerage services in different ways. In addition to traditional
commission-based brokerage, customers can now pay for securities transactions,
related advice, and other services by paying a fee that is a fixed dollar amount
or based on a percentage of assets held on account with the broker-dealer.
Customers can also pay a reduced commission for electronic trading without the
assistance and advice of a registered representative.
While these new programs promise to benefit broker-dealer customers by
aligning their interests more closely with those of the brokerage firm and its
registered representatives, they may also subject the broker-dealers to
regulation under the Advisers Act as well as the Securities Exchange Act of 1934
(Exchange Act). The new programs essentially re-price traditional full service
brokerage programs but do not fundamentally change their nature. Therefore, we
are proposing to use our authority under the Act to adopt a rule that would keep
broker-dealers from being subject to the Advisers Act when they offer these
Under the proposed rule, a broker-dealer providing investment advice to
customers, regardless of the form of its compensation, would be excluded from
the definition of investment adviser as long as: (i) the advice is provided on a
non-discretionary basis; (ii) the advice is solely incidental to the brokerage
services; and (iii) the broker-dealer discloses to its customers that their
accounts are brokerage accounts. The rule also would keep a broker-dealer
providing advice to customers from being subject to the Advisers Act solely
because it also offers execution-only brokerage services at reduced commission
rates. Finally, the proposed rule will clarify that broker-dealers that are
subject to the Advisers Act are subject to the Act only with respect to advisory
clients. We are also proposing to amend the instructions for Form ADV under the
Advisers Act to clarify how broker-dealers calculate the aggregate assets under
management of their advisory clients for determining whether they must register
with the Commission.
Until the Commission takes final action on the proposed rule, the Division of
Investment Management will not recommend, based on the form of compensation
received, that the Commission take any action against a broker-dealer for
failure to treat any account over which the broker-dealer does not exercise
investment discretion as subject to the Act.
The Advisers Act regulates the activities of certain "investment
advisers," which are defined in Section 202(a)(11) as persons who receive
compensation for providing advice about securities as part of a regular
202(a)(11)(C) of the Advisers Act excepts from the definition a broker or dealer
"whose performance of [advisory] services is solely incidental to the
conduct of his business as a broker or dealer and who receives no special
The broker-dealer exception "amounts to a recognition that brokers and
dealers commonly give a certain amount of advice to their customers in the
course of their regular business and that it would be inappropriate to bring
them within the scope of the [Advisers Act] merely because of this aspect of
Many securities firms currently are registered with us under both the
Exchange Act4 (as
broker-dealers) and the Advisers Act (as advisers), but treat only certain of
their accounts as subject to the Advisers Act. We have viewed the Advisers Act
as applying only to those persons to whom the broker-dealer provides investment
advice that is not incidental to brokerage services or for which the firm
receives special compensation.5
The protections of the Advisers Act and our rules must only be afforded those
persons ("advisory clients"). For example, only advisory clients must
be delivered an informational brochure.6
Recently, several full service brokerage firms have introduced or announced
new types of brokerage programs that raise questions as to whether they are
receiving special compensation and, as a result, whether they continue to be
eligible for the broker-dealer exception to the Advisers Act. In the case of
broker-dealers already registered under the Act, these programs raise the
question of whether customers selecting these new programs must be treated as
advisory clients. For convenience, we will refer to these programs as
Fee-based programs offer customers a package of brokerage services --
including execution, investment advice, custodial and recordkeeping services --
for a fixed fee or a fee based on the amount of assets on account with the
broker-dealer. In some programs, broker-dealers also assess a fixed charge for
each transaction.8 These
fee-based programs benefit customers by better aligning their interests with
those of their broker-dealers, and thus are responsive to the best practices
suggested in the Report of the Committee on Compensation Practices ("Tully
Report").9 Under these
programs, broker-dealers' and their registered representatives' compensation no
longer depends on the number of transactions or the size of mark-ups or
mark-downs charged, thus reducing incentives for registered representatives to
churn accounts, recommend unsuitable securities, or engage in high-pressure
sales tactics. The Commission welcomes the introduction of these programs, which
may reduce substantially conflicts between broker-dealers and their customers.
Some full service brokerage firms are also "unbundling" brokerage
services, giving customers the option of purchasing execution-only services at a
reduced commission rate.10
These execution-only programs often give customers the ability to trade
securities over the Internet without the assistance of a registered
representative. These programs offer customers who do not want or need
investment advice the ability to trade securities at a lower commission rate.11
Both types of programs may result in the loss of the broker-dealer exception
to the Advisers Act. Fee-based compensation may constitute special compensation
under the Act because it involves the receipt by a broker of compensation other
than traditional brokerage commissions.12 In addition, the introduction of execution-only
services at a lower commission rate may trigger application of the Act to the
full service accounts for which the broker provides some investment advice. This
is because the difference between full service and execution-only commission
rates represents a clearly definable portion of a brokerage commission that is
attributable, at least in part, to investment advice. We have viewed such a
two-tiered fee structure as an indication of "special compensation"
under the Advisers Act.13
These new programs are not, however, fundamentally different from traditional
brokerage programs not subject to the Advisers Act. Fee-based brokerage programs
offer the same package of services as traditional full-service broker-dealer
programs. Execution-only programs do not offer any advisory service, but
merely make visible that which has always been apparent -- a portion of
commissions charged by full service broker-dealers compensated the broker-dealer
for advisory services. The re-pricing of traditional brokerage services in the
fee-based programs has regulatory implications only because the broker-dealer
exception is limited to broker-dealers not receiving special compensation.
As discussed above, we believe that broker-dealers offering fee-based
programs may be receiving "special compensation" under the Advisers
Act. We do not believe, however, that Congress intended these programs, which
are not substantially different from traditional brokerage arrangements, to be
subject to the Act. While in 1940 the form of compensation a broker-dealer
received may have been a reliable distinction between brokerage and advisory
services, development of the new brokerage programs suggest strongly that it is
no longer. Moreover, we are concerned that, as a result of these new programs,
most brokerage arrangements by full service broker-dealers may be subject to
regulation under both the Advisers Act and the Exchange Act, a result Congress
could not have intended. We are therefore proposing a new rule, described below,
that would deem a broker-dealer not to be an adviser solely as a result of
receiving special compensation, provided certain conditions are met. The
proposed exception would be limited to circumstances where the Commission
believes that Congress did not intend to apply the Advisers Act.
A. Broker-Dealers Deemed Not To Be Investment Advisers
The Commission is proposing new rule 202(a)(11)-1 under the Advisers Act. The
rule is designed to avoid application of the Advisers Act to broker-dealers
solely because they re-price their full-service brokerage or provide
execution-only services in addition to full service brokerage. The rule would
also codify our long-standing view of how the Act applies to broker-dealers that
are registered advisers.
1. Fee-Based Brokerage Programs
Under the proposed rule, a broker-dealer providing investment advice to its
brokerage customers would not be required to treat those customers as advisory
clients solely because of the form of the broker-dealer's compensation. The
proposed rule would be available to broker-dealers registered under the Exchange
Act that satisfy three conditions: (i) the broker-dealer must not exercise
investment discretion over the account from which it receives special
compensation; (ii) any investment advice is incidental to the brokerage service
provided to each account; and (iii) advertisements for and contracts or
agreements governing the account must contain a prominent statement that it is a
Under the rule, the nature of the services provided, rather than the form the
broker-dealer's compensation takes, would be the primary feature distinguishing
an advisory account from a brokerage account. Discretionary accounts that are
charged an asset-based fee would be considered advisory accounts because they
bear a strong resemblance to traditional advisory accounts, and it is highly
likely that investors will perceive such accounts to be advisory accounts.15 Under the statute, however,
discretionary accounts from which a broker-dealer does not receive special
compensation, e.g., accounts that pay commissions, would still be treated
as brokerage accounts not subject to the Act. In this respect, a regulatory
distinction would continue to be drawn based solely on the pricing of an
advisory service. We request comment on whether this remains an appropriate
distinction. Should all discretionary accounts of broker-dealers be treated as
The proposed rule would include the requirement, taken from the broker-dealer
exception, that the advisory services provided the account be incidental to the
brokerage services provided.17
The rule would clarify that the advice the broker-dealer provides must be
incidental to brokerage services provided by the broker-dealer to each account
rather than the overall operations of the broker-dealer.
Finally, the proposed rule would require that all advertisements for the
accounts and all agreements and contracts governing the operation of the
accounts contain a prominent statement that the accounts are brokerage accounts.18 We have observed that some
broker-dealers offering these new accounts have heavily marketed them based on
the advisory services provided rather than the execution services, which raises
troubling questions as to whether the advisory services are not (or will be
perceived by investors not to be) incidental to the brokerage services. We have,
however, never viewed the broker-dealer exception as precluding a broker-dealer
from marketing itself as providing some amount of advisory services.19 Comment is requested as to
whether, instead of the proposed disclosure, we should preclude brokers from
relying on the rule if they market these accounts in such a way as to suggest
they are advisory accounts.
Under the proposed rule, broker-dealer sponsors of wrap fee programs would
continue to treat wrap fee accounts as advisory accounts.20 Wrap fee program sponsors that
also provide portfolio management services typically have discretionary
authority over the accounts, and thus could not use the rule. In many cases,
sponsors of wrap fee programs execute transactions for wrap accounts and provide
some non-discretionary advisory services such as asset allocation or selection
of portfolio managers. The sponsors do not themselves have discretionary
authority, which is delegated to an advisory firm that receives a portion of the
wrap fee. In these cases, the non-discretionary advisory services provided by
the sponsor could not be viewed as incidental to the brokerage services.21
2. Execution-Only Brokerage Programs
Proposed rule 202(a)(11)-1 would also keep a full service broker-dealer from
being subject to the Act solely because it also offers execution-only brokerage.22 Conversely, a discount broker
would not be subject to the Act solely because it introduces a full service
brokerage program. Under the rule, a broker-dealer would not be considered to
have received special compensation solely because the broker-dealer charges a
commission, mark-up, mark-down or similar fee for brokerage services that is
greater than or less than one it charges another customer. Thus, a broker-dealer
would be able to offer both full-service and execution-only brokerage without
losing the broker-dealer exception. This provision would make a broker-dealer's
eligibility for the broker-dealer exception with respect to an account turn on
the characteristics of that account and not others.
3. Scope of Broker-Dealer Exception
As discussed above, a broker-dealer registered under both the Exchange Act
(as a broker-dealer) and the Advisers Act (as an adviser) need not treat all of
its customers as advisory clients. We have viewed the Advisers Act as applying
only to those customers to whom the broker-dealer provides advice that is not
incidental to brokerage services or for which the firm receives special
compensation.23 We have
included a provision in the proposed rule codifying this view.24
B. Calculation of Assets under Management for Broker-Dealers
Generally, only investment advisers with at least $25 million of assets under
management must register with the Commission.25 Advisers with fewer assets under management
generally must register with one or more state securities authorities.26 The staff has taken the position
that broker-dealers may include in their calculation of assets under management
the value of brokerage accounts that receive continuous and regular supervisory
or management services.27
We are proposing to codify this position by amending the instructions to
Schedule I of Form ADV, but limiting it to accounts over which broker-dealers
exercise investment discretion.28
III. General Request For Comment
Any interested persons wishing to submit written comments on the proposed
rule that is the subject of this release, or submit comments on other matters
that might have an effect on the proposals described above, are requested to do
so. Commenters suggesting alternative approaches are encouraged to submit
proposed rule text.
For purposes of the Small Business Regulatory Enforcement Fairness Act of
1996, the Commission also is requesting information regarding the potential
impact of the proposed rule on the economy on an annual basis. Commenters should
provide empirical data to support their views.
IV. Paperwork Reduction Act
Certain provisions of proposed Rule 202(a)(11)-1 contain a "collection
of information" within the meaning of the Paperwork Reduction Act of 1995
(44 U.S.C. 3501 to 3520), and the Commission has submitted it to the Office of
Management and Budget in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11.
The title for the collection of information is "Certain Broker-Dealers
Deemed Not To Be Investment Advisers." An agency may not sponsor, conduct,
or require response to an information collection unless a currently valid OMB
control number is displayed.
Broker-dealers taking advantage of the proposed rule would need to maintain
certain records that establish their eligibility to do so, but rules under the
Exchange Act already require the maintenance of those records. Specifically,
broker-dealers are currently required to maintain all "evidence of the
granting of discretionary authority given in any respect of any account"29 and all "written
agreements . . . with respect to any account."30 Therefore, the proposed rule will not increase
the recordkeeping burden for any broker-dealer.
For an account to which the proposed rule applies, advertisements31 and contracts or agreements
must include a prominent statement that the account is a brokerage account.32 This information is necessary
to prevent customers and prospective customers from mistakenly believing that
the account is an advisory account subject to the Advisers Act and will be used
to assist clients in making an informed decision on whether to establish an
account. We believe that the burden to comply with this provision of the rule is
insignificant. In preparing model contracts and advertisements, for example,
compliance officials would be required to verify that the appropriate disclosure
is made. For purposes of the Paperwork Reduction Act, the average annual burden
for ensuring compliance is 5 minutes per broker-dealer taking advantage of the
proposed rule. If all of the approximately 8,500 broker-dealers registered with
us took advantage of the rule, the total estimated annual burden would be 706
hours (.083 hours x 8,500 brokers). At an assumed $120 per hour those 706 hours
would cost $84,720. We request comment on these figures.
The collection of information requirements under the proposed rule are
mandatory. In general, the information collected pursuant to the proposed rule
would be held by the broker-dealers. The Commission, self-regulatory
organizations, and other securities regulatory authorities would only gain
possession of the information upon request. Any information received by the
Commission related to the proposed rule would be kept confidential, subject to
the provisions of the Freedom of Information Act, 5 U.S.C. 552.
Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits comments to (i)
evaluate whether the proposed collection of information is necessary for the
proper performance of the functions of the agency, including whether the
information will have practical utility; (ii) evaluate the accuracy of the
agency's estimate of the burden of the proposed collection of information; (iii)
enhance the quality, utility, and clarity of the information to be collected;
and (iv) minimize the burden of the collections of information on those who are
to respond, including through the use of automated collection techniques or
other forms of information technology.
Persons desiring to submit comments on the collection of information
requirements should direct them to the Office of Management and Budget,
Attention: Desk Officer for the Securities and Exchange Commission, Office of
Information and Regulatory Affairs, Washington, D.C. 20503, and also should send
a copy of their comments to Jonathan G. Katz, Secretary, Securities and Exchange
Commission, 450 5th Street, N.W., Stop 6-9, Washington, D.C. 20549 with
reference to File No. 270-471. OMB is required to make a decision concerning the
collection of information requirements between 30 and 60 days after publication.
A comment to OMB is best assured of having its full effect if OMB receives it
within 30 days of publication.
V. Cost-Benefit Analysis
The proposed rule would keep broker-dealers from being subject to the
Advisers Act solely as a result of re-pricing their full-service brokerage
services. Proposed rule 202(a)(11)-1 would have no effect on the regulatory
burden borne by investment advisers because it only operates to exempt from the
Advisers Act certain brokerage accounts. For broker-dealers that would otherwise
be subject to the Advisers Act, the proposed rule would reduce their regulatory
burden.33 Thus, the
benefits to broker-dealers to which the proposed rule would apply are
substantial in terms of avoiding an increased regulatory burden stemming from
re-pricing their brokerage services.
Substantial benefits for individual investors from the repricing of brokerage
services, and therefore from the proposed rule which eliminates unintended
regulatory disincentives to that repricing, are expected. Under the fee-based
programs discussed above, a broker-dealer's or registered representative's
compensation no longer depends on the number of transactions or the size of
mark-ups or mark-downs charged, thus reducing incentives for a registered
representative to churn accounts, recommend unsuitable securities, or engage in
high-pressure sales tactics. Thus, these programs may better align the interests
of broker-dealers and their customers.
While the benefits of the proposed rule are substantial (although difficult
to quantify), the incremental costs associated with the rule are small.
Broker-dealers taking advantage of the rule will need to maintain certain
records establishing their eligibility for the rule (e.g., contracts or
agreements governing the accounts and advertisements related to the accounts),
but rules under the Exchange Act already require the maintenance of those
records. Thus, the only incremental cost associated with the rule is the cost of
adding a statement to those documents that the accounts are brokerage accounts.
As discussed in the Paperwork Reduction Act analysis above, we believe this cost
Comment is requested on issues relating to the proposed rule's costs and
benefits. Commenters are requested to provide views and empirical data relating
to any costs and benefits associated with the proposed rule and form amendment.
VI. Initial Regulatory Flexibility Analysis
The Commission has prepared the following Initial Regulatory Flexibility
Analysis ("IRFA") in accordance with 5 U.S.C. 603 regarding proposed
A. Reasons for Proposed Action
Broker-dealers recently have begun to give their customers the option of
paying for securities transactions, related advice, and other services by paying
a fee that is a fixed dollar amount or based on a percentage of assets held on
account with the broker-dealer. While these new programs promise to benefit
broker-dealer customers by aligning their interests more closely with those of
the brokerage firm and its registered representatives, they may also subject the
broker-dealers to regulation under the Advisers Act. The new programs
essentially re-price traditional full service brokerage programs but do not
fundamentally change their nature. Subjecting broker-dealers that offer these
programs to the Advisers Act would impose unnecessary regulatory burdens on the
provision of brokerage services contrary to the intent of Congress when it
passed the Advisers Act.
B. Objectives and Legal Basis
The proposed rule is designed to prevent application of the Advisers Act to
broker-dealers solely because they re-price their full-service brokerage or
provide execution-only services in addition to full service brokerage. The rule
would also codify certain long-standing positions regarding application of the
Advisers Act to broker-dealers that are registered advisers. We are proposing
the rule pursuant to our authority under Sections 202(a)(11)(F)34 and 211(a)35 under the Act. Section
202(a)(11)(F) gives us authority to except, by rule or order, from the statutory
definition of "investment adviser" persons not within the intent of
that definition. Section 211(a) gives us authority to classify, by rule, persons
and matters within our jurisdiction and to prescribe different requirements for
different classes of persons, as necessary or appropriate to the exercise of our
authority under the Act.
C. Small Entities Subject to Rule
For the purposes of the Exchange Act and the Regulatory Flexibility Act, a
broker-dealer, under Commission rules, generally is a small entity if it had
total capital (net worth plus subordinated liabilities) of less than $500,000 on
the date in the prior fiscal year as of which its audited financial statements
were prepared and it is not affiliated with any person (other than a natural
person) that is not a small entity.36
The Commission estimates that as of December 31, 1998, approximately 1,000
Commission-registered broker-dealers were small entities.37 The Commission is not aware of
any small entities that are re-pricing their brokerage services in a manner that
the proposed rule addresses, but assumes that all of these small entities could
be affected by the proposed rule.
D. Reporting, Recordkeeping, and Other Compliance Requirements
The proposed rule would impose no new recordkeeping requirements, and will
not materially alter the time required for broker-dealers to comply with the
Commission's rules. The proposed rule keeps unnecessary regulatory burdens from
being imposed on broker-dealers. Broker-dealers taking advantage of the rule are
required to make certain disclosures to customers and potential customers in
advertising and contractual materials.
E. Duplicative, Overlapping, or Conflicting Federal Rules
The Commission believes that there are no rules that duplicate, overlap, or
conflict with, the proposed rule.
F. Significant Alternatives
The Regulatory Flexibility Act directs the Commission to consider significant
alternatives that would accomplish the stated objective, while minimizing any
significant adverse impact on small entities. In connection with the proposed
rule, the Commission considered the following alternatives: (a) the
establishment of differing compliance or reporting requirements or timetables
that take into account the resources available to small entities; (b) the
clarification, consolidation, or simplification of compliance and reporting
requirements under the rule for such small entities; (c) the use of performance
rather than design standards; and (d) an exemption from coverage of the rule, or
any part thereof, for such small entities.
The proposed rule is designed to eliminate unnecessary regulatory burdens
that otherwise might be imposed on broker-dealers. Small entities, as well as
large entities, will benefit from the proposed rule. It is thus inappropriate to
exempt small entities from the proposed rule. The provision of the proposed rule
requiring certain disclosures to customers and potential customers is designed
to prevent investors from being misinformed regarding the nature of the services
they are receiving. Consequently, it would be inconsistent with the purposes of
the Advisers Act to use performance standards to specify different requirements
for small entities.
The Commission believes that the proposed rule will not adversely affect
small entities because it does not impose significant, new reporting,
recordkeeping, or compliance requirements. Instead, the proposed rule would
avoid the imposition of unnecessary regulatory burdens on the provision of
brokerage services solely because broker-dealers re-price their full-service
brokerage or provide execution-only services in addition to full service
brokerage. Therefore, it is not feasible to further clarify, consolidate or
simplify the rule's provisions for small entities.
G. Solicitation of Comments
We encourage written comments on matters discussed in this IRFA. In
particular, the Commission seeks comment on: (i) the number of small entities
that would be affected by the proposed rule; and (ii) whether the impact of the
proposed rule on small entities would be economically significant. Commenters
are asked to describe the nature of any impact and provide empirical data
supporting the extent of the impact.
VII. Statutory Authority
We are proposing the rule pursuant to our authority under Sections
202(a)(11)(F) and 211(a) under the Act. Section 202(a)(11)(F) gives us authority
to except, by rule or order, from the statutory definition of "investment
adviser" persons not within the intent of that definition.38 Section 211(a) gives us
authority to classify, by rule, persons and matters within our jurisdiction and
to prescribe different requirements for different classes of persons, as
necessary or appropriate to the exercise of our authority under the Act.
Text Of Proposed Rule
List of Subjects in 17 CFR Parts 275 and 279
Reporting and recordkeeping requirements.
For the reasons set out in the preamble, Title 17, Chapter II of the Code of
Federal Regulations is proposed to be amended as follows:
PART 275 -- RULES AND REGULATIONS, INVESTMENT ADVISERS ACT OF 1940
1. The general authority citation for Part 275 is revised to read as follows:
AUTHORITY: 15 U.S.C. 80b-2(a)(11)(F), 80b-2(a)(17), 80b-3, 80b-4,
80b-6(4), 80b-6a, 80b-11, unless otherwise noted.
* * * * *
2. Section 275.202(a)(11)-1 is added to read as follows:
§ 275.202(a)(11)-1 Certain broker-dealers deemed not to be investment
A broker or dealer registered with the Commission under Section 15 of the
Securities Exchange Act of 1934 (15 U.S.C. 78o) (the "Exchange Act"):
(a) Will not be deemed to be an investment adviser based solely on its
receipt of special compensation, provided that:
(1) The broker or dealer does not exercise investment discretion, as that
term is defined in Section 3(a)(35) of the Exchange Act (15 U.S.C. 78c(a)(35)),
over the accounts from which it receives special compensation;
(2) Any investment advice provided by the broker or dealer with respect to
accounts from which it receives special compensation is solely incidental to the
brokerage services provided to those accounts; and
(3) Advertisements for, and contracts or agreements governing, accounts for
which the broker or dealer receives special compensation include a prominent
statement that the accounts are brokerage accounts;
(b) Will not be deemed to have received special compensation solely because
the broker or dealer charges a commission, mark-up, mark-down or similar fee for
brokerage services that is greater than or less than one it charges another
(c) Is an investment adviser solely with respect to those accounts for which
it provides services or receives compensation that subject the broker or dealer
to the Act.
PART 279 -- FORMS PRESCRIBED UNDER THE INVESTMENT ADVISERS ACT OF 1940
3. The authority citation for Part 279 continues to read as follows:
AUTHORITY: The Investment Advisers Act of 1940, 15 U.S.C. 80b-1,
4. By amending Instruction 7 in Form ADV Schedule I Instructions (referenced
in § 279.1) by adding paragraph (c)(5) to read as follows:
Note: The text of Form ADV does not and the amendment will not appear in the
Code of Federal Regulations.
* * * * *
Schedule I Instructions
* * * * *
Instruction 7. Determining Assets Under Management
* * * * *
(c) Continuous and Regular Supervisory or Management Services.
* * * * *
Accounts that do not receive continuous and regular supervisory or
* * * * *
(5) Brokerage accounts, unless the applicant has discretionary authority.
* * * * *
Jonathan G. Katz
November 4, 1999
||15 U.S.C 80b-2(a)(11). For a discussion of this definition and the scope of the Advisers Act, see Investment
Advisers Act Release No. 1092 (Oct. 8, 1987) [52 FR 38400 (Oct. 16, 1987)].
||15 U.S.C. 80b-2(a)(11)(C). A person
(including a broker-dealer) that falls within the definition of investment
adviser in Section 202(a)(11) (and is not excepted) must register with the
Commission unless one of the exemptions from registration in Section 203(b) [15
U.S.C. 80b-3(b)] is available or the person is prohibited from registering with
us by Section 203A [15 U.S.C. 80b-3A] because they are a state-regulated
adviser. See Rules Implementing Amendments to the Investment Advisers
Act of 1940, Investment Advisers Act Release No. 1633 (May 15, 1997) [62 FR
28112 (May 22, 1997)].
||Opinion of General Counsel
Relating to Section 202(a)(11)(C) of the Investment Advisers Act of 1940,
Investment Advisers Act Release No. 2 (Oct. 28, 1940) [11 FR 10996 (Oct. 28,
1940)] ("Release No. 2").
||15 U.S.C. 78a.
||Final Extension of Temporary
Rule, Investment Advisers Act Release No. 626 (Apr. 27, 1978) [43 FR 19224
(May 4, 1978)] ("Release No. 626").
||Rule 204-3 [17 CFR 275.204-3].
Additionally, advisory clients must receive, among other things, certain
disclosures about their investment adviser, including disclosure about the
firm's conflicts of interest, other business activities and affiliations,
disciplinary history and, in some cases, financial condition. Rule 206(4)-4 [17
CFR 275.206(4)-4]. Advisory clients' accounts also have restrictions on
effecting principal trades. 15 U.S.C. 80b-6(3).
||For ease of discussion, we assume
in the discussion below that broker-dealers offering fee-based programs are
currently registered with us under the Advisers Act as a result of advisory
activities unrelated to these programs. For broker-dealers that are not
currently registered with us under the Advisers Act, fee-based programs present
a first question of whether they are subject to the Act and, if so, whether they
must register with us as an adviser.
||"Merrill Adapting to New Breed
of Investors," The Deseret News (Salt Lake City, UT), July 18, 1999;
"A New Order for Brokers," Los Angeles Times, July 4, 1999;
"Prudential Rolls Out Fee-Plus Pricing Alternative," Registered
Representative, July 1999; "Charley's Web: Drawing Rivals into the
Internet, Schwab Takes its Biggest Risk," Investment Dealers Digest,
June 21, 1999; "Online Trading Forces Brokerages to Change," Star
Tribune (Minneapolis, MN), June 7, 1999.
||The Tully Report was prepared by
a committee formed in 1994 at the request of Chairman Arthur Levitt to identify
the brokerage industry's "best practices." Report of the Committee
on Compensation Practices, Apr. 10, 1995. See also "You Should
Get What You Pay for -- and Vice Versa," Los Angeles Times, July 4,
1999; "No More Portfolio-Churning Broker-Dealers," The Washington
Post, June 7, 1999.
||"Merrill Adapting to New
Breed of Investors," The Deseret News (Salt Lake City, UT), July 18,
||Some discount brokers are now
providing some advice to their brokerage customers. "Charley's Web: Drawing
Rivals into the Internet, Schwab Takes its Biggest Risk," Investment
Dealers Digest, June 21, 1999. The distinctions between full service
brokerage firms and discount brokerage firms are thus becoming blurred.
||See Committee on
Banking and Currency, Investment Company Act of 1940 and Investment Advisers Act
of 1940, Report No. 1775, 76th Cong., 3d Sess. 22 (June 6, 1940) (section
202(a)(11)(C) applies to broker-dealers "insofar as their advice is merely
incidental to brokerage transactions for which they receive brokerage
commissions"). See also Financial Planners: Report of the Staff
of the United States Securities and Exchange Commission to the House Committee
on Energy and Commerce's Subcommittee on Telecommunications and Finance,
February 1988 (Appendix B) ("[Special compensation] has been interpreted to
exclude ordinary brokerage commissions . . . unless a `clearly definable' part
of the commission is for investment advice.")
Five years ago we adopted rules for broker-sponsored wrap fee programs based
on our conclusion that wrap fees constitute special compensation. Disclosure
by Investment Advisers Regarding Wrap Fee Programs, Investment Advisers Act
Release No. 1401 (Jan. 13, 1994) at n.2 (proposing amendments to Form ADV) [59
FR 3033 (Jan. 20, 1994)]; Investment Advisers Act Release. No. 1411 (Apr. 19,
1994) (adopting amendments to Form ADV) [59 FR 21657 (Apr. 26, 1994)]. See
also National Regulatory Services, SEC No-Action Letter (Dec. 2,
1992). The compensation in the new, fee-based programs is
indistinguishable from wrap fee compensation.
||Release 626, supra at
note 5. See also Release No. 2, supra at note 3; Robert S.
Strevell, SEC No-Action Letter (Apr. 29, 1985) ("If two general fee
schedules are in effect, either formally or informally, the lower without
investment advice and the higher with investment advice, and the difference is
primarily attributable to this factor, there is special compensation.")
||See Release 626, supra
at note 5.
||In Release 626, supra at
note 5, we stated that broker-dealer relationships "which include
discretionary authority to act on a client's behalf have many of the
characteristics of the relationships to which the protections of the Advisers
Act are important," and indicated that we were considering taking action
that would make the broker-dealer exception not available to broker-dealers that
exercised discretionary authority. We also noted in Release 626 the staff's
position that broker-dealers whose business consists almost exclusively of
managing accounts on a discretionary basis are not providing advice solely on an
incidental basis, and thus are subject to the Advisers Act.
202(a)(11)-1(a)(3). An advertisement would include any notice, circular, letter
or other written communication addressed to more than one person, or any notice
or other announcement in any publication or by radio or television. See
Rule 206(4)-1(b) [17 CFR 275.206(4)-1(b)] (defining the term
||See Elmer D. Robinson,
SEC No-Action Letter (Jan. 6, 1986); Nathan & Lewis, SEC No-Action
Letter (Apr. 4, 1988). However, a broker-dealer that employs terms such as
"financial planner" merely as a device to induce the sale of
securities might violate the antifraud provisions of the Securities Act of 1933
and the Exchange Act. Cf. In re Haight & Co., Inc., Securities
Exchange Act Release No. 9082 (Feb. 19, 1971) (Broker-dealer defrauded its
customers in the offer and sale of securities by holding itself out as a
financial planner that would give comprehensive and expert planning advice and
choose the best investments for its clients from all available securities, when
in fact it was not an expert in planning and made its decisions based on the
receipt of commissions and upon its inventory of securities.)
||Sponsors must, therefore,
continue to deliver to wrap fee clients a wrap fee brochure required by Rule
204-3(f) under the Advisers Act [17 CFR 275.204-3(f)]. See also Schedule
H of Form ADV [17 CFR 279.1] (prescribing contents of a wrap fee brochure).
||The brokerage transactions
executed by the sponsor are initiated by the third-party portfolio manager, and
not the sponsor. See generally, National Regulatory Services, SEC
No-Action Letter (Dec. 2, 1992) (wrap fee program is not solely incidental to
the sponsor's business as a broker-dealer); "Mutual Fund Blues? Try a
`Wrap,'" Business Week, July 12, 1999 ("[B]rokerage firms also
offer annual asset-based fees as an alternative to charging commissions on each
trade [but] the accounts don't offer the same services [as wrap
||Proposed rule 202(a)(11)-1(b).
||Release No. 626, supra at
||Proposed rule 202(a)(11)-1(c).
||15 U.S.C. 80b-3A (prohibiting
advisers without assets under management of $25 million or more or that do not
advise a registered investment company from registering with the Commission).
The Commission has adopted a rule that exempts certain types of advisers from
this prohibition. 17 CFR 275.203A-2.
<http://www.sec.gov/rules/othern/advfaq.htm#asst>, "Assets Under
Management," Question No. 5.
||Broker-dealers that are also
registered with us as investment advisers may, in certain circumstances, be
requested during the course of investment adviser inspections by Commission
staff, to provide certain information and records related to their brokerage
clients over whose accounts they exercise investment discretion. For example,
such information and records may be necessary for an evaluation of the reported
amount of assets under management that receive continuous and regular
supervisory or management services.
||17 CFR 240.17a-4(b)(6).
Proposed rule 202(a)(11)-1(a)(1) limits its application to accounts that a
broker-dealer does not exercise investment discretion over.
||17 CFR 240.17a-4(b)(7).
Proposed rule 202(a)(11)-1(a)(3) requires a prominent statement be made in
agreements governing the accounts to which the rule applies.
||Broker-dealers already are
required to maintain records regarding their advertisements under existing
self-regulatory organizations' rules.
||The Commission estimates that
the current annual burden for the approximately 8,500 broker-dealers registered
with us related to the maintenance of these, and other records required by the
Commission is approximately 2.1 million hours. This is the current burden
estimate for Rule 17a-4. It includes the estimated burden from complying with
Rule 17a-4's requirements to maintain certain records unrelated to this rule,
such as customer communications, order tickets, and transaction confirmations.
||Investment advisers are
required, for example, to deliver an informational brochure to clients and
prospective clients, Rule 204-3 [17 CFR 275.204-3], and to make detailed
disclosures about the advisory firm and its supervised persons. Rule 206(4)-4
[17 CFR 275.206(4)-4].
||15 U.S.C. 80b-2(a)(11)(F).
||15 U.S.C. 80b-11(a).
||17 CFR 240.0-10(c).
||This estimate is based on the
information provided in Form X-17A-5 Financial and Operational Combined Uniform
Single Reports filed pursuant to Section 17 of the Exchange Act and Rule 17a-5
||Because we are using our
authority under Section 202(a)(11)(F), broker-dealers relying on the rule would
not be subject to state adviser statutes. Section 203A(b)(1)(B) of the Act [15
U.S.C. 80b-3A(b)(1)(B)] provides that "[n]o law of any State or political
subdivision thereof requiring the registration, licensing, or qualification as
an investment adviser or supervised person of an investment adviser shall apply
to any person . . . that is not registered under [the Advisers Act] because that
person is excepted from the definition of an investment adviser under section
202(a)(11)." (emphasis added).