Fix disparate regs that govern broker-dealers and investment advisers, authors suggest

The current system regulating two distinct groups that offer investment advice — broker-dealers and their reps and registered investment advisers — is broken, and needs overhauling by Congress, according to a new report presented earlier this month at the annual client meeting of Jersey City, N.J.-based Pershing LLC in Hollywood, Fla.

The report, “A New Paradigm for Federal Regulation of Financial Intermediaries,” written by Stuart J. Kaswell and Corey F. Rose, condemns the system as a hodgepodge and argues it should be replaced by “a new system that will provide more meaningful investor protections on a methodical basis.

“The current system of regulating broker-dealers and investment advisers serves neither investors nor the financial services industry,” wrote Mr. Kaswell and Mr. Rose, a partner and an associate, respectively, at Dechert LLP of Washington. Mr. Kaswell was formerly general counsel at the Securities Industry Association.

Noting that Congress enacted the current regulatory system on a piecemeal basis during the New Deal, the report says “the current system is an accident of history and imposes restrictions that are too lax in some settings and too restrictive in others. With the benefit of 70 years of experience, we can do better.”

The report was sponsored by Federated Investors Management Co. Inc. of Pittsburgh.

Indeed, securities regulators strongly desire to create a “level playing field” between broker-dealers, which traditionally charge clients commissions, and registered investment advisers, who charge fees, one consultant said.

The regulations governing investment advisers are “less arduous” than those overseeing broker-dealers, a disparity that has led to an “exodus” of some brokers from that side of the business, said John Hurley, managing director with Suasion Resources Inc., a Roseland, N.J.-based consulting firm for financial services companies. “I do think the regulators are looking at this very closely,” he said.

“This exodus has been a concern, particularly to certain independent broker-dealers,” because they don’t want to lose more of their reps to the advisory business, Mr. Hurley said.

The Securities and Exchange Commission, along with the states, oversees investment advisers, while the Financial Industry Regulatory Authority Inc. of New York and Washington regulates broker-dealers and their reps.

The report recommended “moving the best aspects of the broker-dealer and investment regimes into new, ‘neutral’ states.” That would mean overhauling the current legal framework for brokers and advisers, lumping them together as “financial intermediaries” in the proposed Financial Intermediaries Act of 2008, according to the report.

“We respectfully suggest that the time has come for Congress to create a new regulatory regime to replace the current systems for regulating broker-dealers and investment advisers” and enact the FIA, the report stated.

UNIFORM REGISTRATION

To create a uniform registration requirement, Congress should first repeal both Section 15 of the Securities Exchange Act of 1934 and the Investment Advisers Act of 1940. Lawmakers should then take the “substantive portions of the repealed provisions” and enact them in the FIA, according to the report.

Congress should have three classifications of “financial intermediary,” according to the paper.

The first two classifications need to include anyone currently defined as a “broker” or “dealer” under specific provisions of the Exchange Act, along with any person defined as an “investment adviser” under the Advisers Act.

This would smooth out some discrepancies between broker-dealers and investment advisers, the report stated. “Congress would avoid inadvertently including or exempting entities that currently fall within the existing definitions.”

And once a uniform registration requirement is created, Congress could create a structure to regulate brokers and advisers based on what they sell or provide for clients rather than how they are registered, the report stated.

E-mail Bruce Kelly at [email protected].