[Federal Register Volume 64, Number 217 (Wednesday, November 10, 1999)]
[Proposed Rules]
[Pages 61226-61232]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-29395]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 275 and 279

[Release Nos. 34-42099; IA-1845; File No. S7-25-99]
RIN 3235-AH78


Certain Broker-Dealers Deemed Not To Be Investment Advisers

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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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.


[[Page 61227]]


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: [email protected]. 
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 protected], 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

Executive Summary
I. Background
II. Discussion
    A. Broker-Dealers Deemed Not To Be Investment Advisers
    1. Fee-Based Brokerage Programs
    2. Execution-Only Brokerage Programs
    3. Scope of Broker-Dealer Exception
    B. Calculation of Assets under Management for Broker-Dealers
III. General Request For Comment
IV. Paperwork Reduction Act
V. Cost-Benefit Analysis
VI. Initial Regulatory Flexibility Analysis
VII. Statutory Authority
Text of Proposed Rule

Executive Summary

    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 
programs.
    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.

I. Background

    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 business.\1\ Section 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 compensation 
therefor.'' \2\ 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 their business.'' \3\
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    \1\ 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)].
    \2\ 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)].
    \3\ 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'').
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    Many securities firms currently are registered with us under both 
the Exchange Act \4\ (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\
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    \4\ 15 U.S.C. 78a.
    \5\ Final Extension of Temporary Rule, Investment Advisers Act 
Release No. 626 (Apr. 27, 1978) [43 FR 19224 (May 4, 1978)] 
(``Release No. 626'').
    \6\ 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).
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    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

[[Page 61228]]

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.'' \7\
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    \7\ 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.
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    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.
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    \8\ ``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.
    \9\ 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.
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    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\
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    \10\ ``Merrill Adapting to New Breed of Investors,'' The Deseret 
News (Salt Lake City, UT), July 18, 1999.
    \11\ 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.
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    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\
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    \12\ 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.
    \13\ 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.'')
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    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.

II. Discussion

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.

[[Page 61229]]

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 brokerage account.\14\
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    \14\ Proposed rule 202(a)(11)-1(a)(1)-(3).
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    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 advisory 
accounts? \16\
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    \15\ See Release 626, supra at note 5.
    \16\ 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.
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    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.
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    \17\ Proposed rule 202(a)(11)-1(a)(2).
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    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.
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    \18\ Proposed rule 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 
``advertisement'').
    \19\ 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.)
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    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\
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    \20\ 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).
    \21\ 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 accounts].'')
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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.
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    \22\ Proposed rule 202(a)(11)-1(b).
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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\
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    \23\ Release No. 626, supra at note 5.
    \24\ Proposed rule 202(a)(11)-1(c).
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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

[[Page 61230]]

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\
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    \25\ 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.
    \26\ Id.
    \27\ See <http://www.sec.gov/rules/othern/advfaq.htm#asst>, 
``Assets Under Management,'' Question No. 5.
    \28\ 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.
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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.
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    \29\ 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.
    \30\ 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.
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    For an account to which the proposed rule applies, advertisements 
\31\ 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.
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    \31\ Broker-dealers already are required to maintain records 
regarding their advertisements under existing self-regulatory 
organizations' rules.
    \32\ 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.
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    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

[[Page 61231]]

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.
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    \33\ 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].
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    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 is insignificant.
    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 rule 202(a)(11)-1.

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.
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    \34\ 15 U.S.C. 80b-2(a)(11)(F).
    \35\ 15 U.S.C. 80b-11(a).
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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\
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    \36\ 17 CFR 240.0-10(c).
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    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.
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    \37\ 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 
thereunder.
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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

[[Page 61232]]

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.
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    \38\ 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).
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List of Subjects in 17 CFR Parts 275 and 279

    Reporting and recordkeeping requirements.

Text of Proposed Rule

    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:


Sec. 275.202(a)(11)-1  Certain broker-dealers deemed not to be 
investment advisers.

    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 customer; and
    (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, 
et seq.

    4. By amending Instruction 7 in Form ADV Schedule I Instructions 
(referenced in Sec. 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.
Form ADV
* * * * *
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 
management services: 
* * * * *
    (5) Brokerage accounts, unless the applicant has discretionary 
authority.
* * * * *
    Dated: November 4, 1999.

    By the Commission.
Jonathan G. Katz,
Secretary.
[FR Doc. 99-29395 Filed 11-9-99; 8:45 am]
BILLING CODE 8010-01-P