SEC Provides Guidance As to What Constitutes Investment Advisory Activities

May 31, 2005

The SEC’s recent adoption of the controversial rule, Certain Broker-Dealers Deemed not to be Investment Advisers, does not appear to have a direct effect on the compliance practices of existing RIA firms; however, it does require significant action to be taken by brokers-dealers that are conducting what have usually been considered advisory services.

While we believe that the SEC did not go far enough in reigning in the advisory activities of BDs, the new rule does provide some much needed guidance for the industry. Here are three examples of items from the new rule that many BDs will have to address and resolve within the next two months:

Assets Under Management – BDs may provide brokerage services on an “assets under management” or fixed fee basis without registering as an advisor. This has been a point of contention throughout the industry for several years, and the SEC has ruled on the side of BDs for this one. While BDs may continue to conduct these services, they need to disclose to the investing public that their services are brokerage only and not advisory in nature. In fact, the SEC has developed specific disclosure language that BDs must use in advertising and all agreements, contracts, applications, and other forms governing the operation of non-advisory, fee based accounts. The disclosure language must be in place by July 22, 2005.

Non-Discretionary – A BD’s non-advisory, fee-based services must be done on a non-discretionary basis. The SEC has correctly ruled that discretionary brokerage services should only be conducted by an investment advisor. Therefore, if you are a BD registered rep with discretionary accounts, you need to either 1) move those accounts to an advisory platform, which may mean registering as an investment advisor, or 2) release the discretionary authority. Either way, you have until October 24, 2005 to comply with this part of the rule.

No Financial Planning – BDs may not provide financial planning services. With respect to this particular issue, the SEC ruled on the side of investment advisors and industry organizations such as the Financial Planning Association. The SEC has correctly interpreted that financial planning is an investment advisory activity. According to the rule, you need to register as an investment advisor if you are a broker or dealer that 1) provides financial planning services to clients; 2) advertises financial planning services; 3) maintains a listing as a financial planning in a telephone or building directory; 4) lets it be known by word of mouth or otherwise that new financial planning clients will be accepted; or 5) uses letterhead or business cards referring to financial planning services. Again, B/Ds will have until October 24, 2005 to move these accounts to an advisory platform. However, because the advertising requirements go into effect July 22, 2005, BDs should stop advertising financial planning services by that date.

While BDs may continue to provide fee-based brokerage services and consequently not need to be registered as an investment advisor, we fully expect many BDs will get registered in order to continue providing discretionary and/or financial planning services. We also expect the debate on this issue to continue, so stay tuned to RIA Compliance Consultants for the latest information.

Posted by Bryan Hill
Labels: SEC