November 17, 2003
The Honorable William H. Donaldson
Dear Chairman Donaldson:
AARP urges the U.S. Securities and Exchange Commission (SEC, or the Commission) to reconsider and revise the proposed rule (Rule 202(a)(11)-1; File No. S7-25-99) that would further reduce the limited protections offered by the Investment Advisors Act of 1940 (Advisors Act). AARP has not previously commented on this proposed ruling1, which has been under extended review by the Commission since January 14, 2000.
The accounting and reporting misdeeds of publicly-traded corporations, and the recent allegations of misconduct within the mutual fund industry, have revealed
how vulnerable ordinary investors have become under a weakened regime of investor protections. The proposed Rule 202(a)(11) would further weaken this regime by redefining a number of statutory terms that have served to mark the legal distinction between broker-dealers and investment advisers for over 60 years. We agree that a revision of the existing regulations is in order. However, we do not believe that the proposed rule gives appropriate and definitive guidance where it is needed.
Under the proposed rule, a broker-dealer that provides investment advice to customers, without regard to the form of compensation, would be excluded from the definition of investment adviser. That is, broker-dealers would be exempt from complying with the basic investor protections provided for in the Advisory Act as long as:
The proposed rule allows brokers who receive "special compensation" for providing investment advice to be granted a broker-dealer exclusion from the requirements of Investment Advisers Act if the advice offered is "solely incidental" to the broker-dealer's primary business. In effect, the proposed rule would eliminate receipt of special compensation for advice as a bright-line test for screening requests for the exclusion while failing to provide any substantive clarification of what does and does not qualify as solely incidental advice. Implementation of the proposed rule would further blur and weaken the investor protections afforded by the Act.
Therefore, we believe the Commission should provide more explicit guidance to broker-dealers, investment advisers and, most importantly, to investors than is exhibited in the proposed rule. The distinctions drawn between brokerage and advisory services, and how these classifications will be enforced - as market conditions and practices change and new technologies advances and applications emerge - are critical to the reestablishment of trust and confidence by investors in the post-ENRON environment.
Many investor protection advocates have detailed for the Commission the well funded campaigns that full service brokers have designed to attract consumers to their new programs. These advertising expenditures emphasize advisory services and the merits of asset-based compensation. Given the prominence of these efforts, we believe it is imperative that the Commission take prompt and decisive action that will help investors understand the types of services that are available and the differences between brokerage and advisory services.
We believe the proposed reforms are inadequate, and consumers need a new framework that provides greater insight and transparency. We believe that the rule should be revised to treat discretionary brokerage accounts that charge commissions in the same manner that it treats discretionary brokerage accounts that are fee-based. The rule should clarify that an account that receives discretionary advisory services is by definition not "solely incidental" to a broker-dealer's business. The rule should also prohibit broker-dealers from advertising advisory services that are "solely incidental" to the conduct of the broker's primary business.
The rule should also require more meaningful disclosure in advertisements and any other materials that market advisory services of broker-deals -- including contracts and agreements governing such accounts -- in order to inform consumers of the significant differences between advisory and brokerage accounts, functions, and legal responsibilities. At a minimum we believe that, given the general lack of financial literacy of most ordinary saver-investors, broker-dealers ought to be required to provide a directly associated disclosure. This disclosure should be prominently displayed and in-plain-language, and indicate whether or which accounts being advertised are or are not advisory accounts under the Act.
In the proposed rule, the Commission notes that broker-dealers offering heavily marketed fee-based advisory services "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." If the fee-based advisory services are "solely incidental" within the meaning of the statute, the prohibition on marketing such accounts could not -- by definition -- have a significant impact on the broker-dealer's business. More importantly, we believe that such a prohibition is necessary for the protection of investors. It is simply misleading for a broker-dealer to market its advisory services when in fact such services are only an insignificant part of the broker's business and the broker is claiming an exclusion from protections provided to investors under the Advisers Act.
Clarifying the rule in this area will provide significant guidance - to the brokerage industry, the investment advisory profession, state and federal regulators, and investors - concerning the circumstances and activities that will subject brokerage accounts to the laws and regulations governing investment advisers. Accordingly, the Commission should reconsider whether the recommended approach is workable, suitable and consistent with the relevant statutory provisions and with the realities of the marketplace. We believe it is not.
We would welcome the opportunity to meet and discuss these issues with you. Please feel free to contact me at (202) 434-3372 or have your staff contact Roy
Green of our Federal Affairs staff at (202) 434-3800, if you have any further questions or need additional information.
Cc: Commissioner Paul Atkins