Taking Sides: Broker-dealer rule leaves too much room for abuse

Harvey Pitt, the president’s choice to take over the Securities and Exchange Commission, hasn’t sat for his confirmation hearing yet. But that hasn’t stopped the Financial Planning Association from taking steps to make sure he gets a clear and unequivocal message on one of the most controversial issues facing him – assuming he’s confirmed and takes office, that is.

The FPA, of course, is making no assumptions. As InvestmentNews reporter Sarah O’Brien points out in her story this week, the organization has written to all 20 members of the Senate Banking Committee.

The letters urge them to question Mr. Pitt on his inclinations about a proposed SEC regulation known informally as the “Merrill Lynch rule.”

Bound by standards

That is not an attempt to deep-six Mr. Pitt’s confirmation. The issue hardly rises to that level. But this is an effort to let Mr. Pitt know just how high the FPA believes the stakes are on this issue.

The SEC proposal was drafted in response to Merrill Lynch & Co. Inc.’s launch almost two years ago of its fee-based asset management program, known as the Unlimited Advantage Account.

Under the Investment Advisers Act of 1940, anyone acting as an investment adviser is required to register with the SEC and meet strict fiduciary requirements. Many financial planners are bound by those standards, either as a registered adviser or through their designation as a certified financial planner.

Among other things, the FPA says, investment advisers are required to provide clients with detailed information about their services, fees and conflicts of interest through extensive disclosure requirements.

But if the proposed rule were to be adopted, broker-dealers would be able to avoid registration and the fiduciary responsibility it entails, yet still act as investment advisers, the FPA contends.

Full-service brokers are opposed to registering because they would be barred from making “principal transactions.” That is, they couldn’t sell securities from their own inventory – a common industry practice at brokerage companies – or recommend stocks without prior permission from their clients.

The proposed rule would waive that prohibition regardless of how a broker-dealer is paid as long as the broker does not have discretion over investing their clients’ money.

At the heart of the matter are two fundamental issues – advice and disclosure.

Are brokers providing advice or merely brokerage services? And will the rule allow them to avoid making disclosures that are important to consumers?

best interests

The Consumer Federation of America and the AARP, an advocacy group for people over age 50, have opposed the rule because they believe it would weaken consumer protection and cause confusion among investors.

On the matter of advice, the brokerage houses argue that they are not marketing any – beyond the information that would be provided in the context of a normal brokerage account.

The FPA argues that full, clear disclosure serves the best interests of all parties, including investors and financial service providers. We concur.

As written, the rule provides far too much latitude to brokerage companies and opens the door for potential abuse.

If companies such as Merrill Lynch are going to have fee-based programs that market advice as one of its components, then to keep the playing field level the same registration standards should apply.

Let’s hope that Mr. Pitt gets the message.