[Federal Register Volume 70, Number 10 (Friday, January 14, 2005)]
[Rules and Regulations]
[Pages 2712-2715]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 05-602]



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Part II





Securities and Exchange Commission





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17 CFR Part 275



Certain Broker-Dealers Deemed Not To Be Investment Advisers; Temporary 
Rule and Proposed Rule

  Federal Register / Vol. 70, No. 10 / Friday, January 14, 2005 / Rules 
and Regulations  

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 275

[Release Nos. 34-50979; IA-2339; File No. S7-25-99]
RIN 3235-AH78


Certain Broker-Dealers Deemed Not To Be Investment Advisers

AGENCY: Securities and Exchange Commission.

ACTION: Adoption of temporary rule.

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SUMMARY: The Securities and Exchange Commission is adopting a temporary 
rule addressing the application of the Investment Advisers Act of 1940 
to broker-dealers offering certain types of brokerage programs. Under 
the rule, a broker-dealer providing nondiscretionary advice that is 
solely incidental to its brokerage services is excepted from the 
Investment Advisers Act regardless of whether it charges an asset-based 
or fixed fee (rather than commissions, mark-ups, or mark-downs) for its 
services. The temporary rule also provides that broker-dealers are not 
subject to the Investment Advisers Act solely because they offer full-
service brokerage and discount brokerage services, including execution-
only brokerage, for reduced commission rates. The temporary rule will 
expire on April 15, 2005.

DATES: Effective Date: Section 275.202(a)(11)T will be effective from 
January 6, 2005 to April 15, 2005.

FOR FURTHER INFORMATION CONTACT: Robert L. Tuleya, Senior Counsel, or 
Nancy M. Morris, Attorney-Fellow, at (202-942-0719), or 
[email protected], Office of Investment Adviser Regulation, Division of 
Investment Management, Securities and Exchange Commission, 450 Fifth 
St., NW., Washington, DC 20549-0506.

SUPPLEMENTARY INFORMATION: The Securities and Exchange Commission 
(``Commission'' or ``SEC'') is adopting temporary rule 202(a)(11)T 
under the Investment Advisers Act of 1940 (``Advisers Act'' or 
``Act'').\1\
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    \1\ 15 U.S.C. 80b-1. Unless otherwise noted, when we refer to 
the Advisers Act, or any paragraph of the Act, we are referring to 
15 U.S.C. 80b of the United States Code in which the Act is 
published.
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Table of Contents

I. Discussion
    A. Temporary Rule
    B. Scope of Exception
II. Cost Benefit Analysis
III. Effects on Competition, Efficiency and Capital Formation
IV. Paperwork Reduction Act
V. Final Regulatory Flexibility Analysis
VI. Statutory Authority Text of Rule

I. Discussion

    On November 4, 1999, the Commission issued a release proposing for 
comment a new rule under the Advisers Act that responded to the 
introduction of two new types of brokerage programs offered by full-
service broker-dealers--``fee-based brokerage programs'' and ``discount 
brokerage programs.'' \2\ Under the proposed rule, a broker-dealer 
providing investment advice to customers would be excluded from the 
definition of investment adviser in the Act regardless of the form that 
its compensation takes, as long as: (i) The advice is provided on a 
nondiscretionary 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. In addition, we 
proposed that a broker-dealer would not be deemed 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. The 
Proposing Release included a statement that, ``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.'' \3\
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    \2\ Certain Broker-Dealers Deemed Not to be Investment Advisers, 
Investment Advisers Act Release No. 1845 (Nov. 4, 1999) [64 FR 61226 
(Nov. 10, 1999)] (``Proposing Release''). We reopened the period for 
public comment on the proposed rule in August 2004. Investment 
Advisers Act Release No. 2278 (Aug. 18, 2004) [69 FR 51620 (Aug. 20, 
2004)]. The comment letters are generally available for viewing and 
downloading on the Internet at http://www.sec.gov/rules/proposed/s72599.shtml. Letters are otherwise available for inspection and 
copying in the Commission's Public Reference Room, 450 Fifth Street, 
NW., Washington, DC 20549 (File No. S7-25-99). In the Proposing 
Release, we referred to what we now term ``discount brokerage'' 
programs as ``execution-only'' programs. ``Discount brokerage'' more 
fully describes the programs covered by this rule.
    \3\ Proposing Release, supra note 2.
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    These new brokerage programs responded to changes in the 
marketplace for retail brokerage. They also addressed concerns we have 
long held about the incentives that commission-based compensation 
provides to churn accounts, recommend unsuitable securities, and engage 
in aggressive marketing of brokerage services.
    The comments we received on the Proposing Release have raised 
complicated and significant issues, including what is solely incidental 
to brokerage and how a broker-dealer can hold itself and its services 
out to the public. These issues extend beyond those originally 
contemplated by the Proposing Release, and suggest the need to 
repropose the rule in the full context of what is ``solely incidental'' 
to brokerage. Accordingly, we are today issuing a companion release 
that requests additional comment on these issues, as well as other 
issues associated with the scope of the broker-dealer exception in the 
Act.\4\ We direct interested parties to that rulemaking.
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    \4\ Investment Advisers Act Release No. 2340 (Jan. 6, 2005) 
(``Companion Release'').
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    As a result of the adoption of this temporary rule, we note that 
the staff no-action position announced in the Proposing Release has 
terminated. Since rule 202(a)(11)-1 was proposed, broker-dealers have 
relied on the staff no-action position. Today, fee-based programs are 
offered by most of the larger broker-dealers and hold over $254 billion 
of customer assets.\5\ Industry observers expect that fee-based 
programs will continue to grow as broker-dealers move away from 
transaction-based brokerage relationships that provide unsteady sources 
of revenue.\6\ In order to avoid the disruption to broker-dealers 
offering these programs and to their customers who invest through them, 
and to provide time for further consideration of the proposal in the 
Companion Release, we are today adopting temporary rule 202(a)(11)T 
under the Advisers Act.\7\
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    \5\ The Cerulli Edge, Managed Accounts Edition (3rd Quarter 
2004).
    \6\ The Cerulli Edge, Managed Accounts Edition (1st Quarter 
2004). See also Robert D. Hershey, Jr., Investing: The Rise of the 
Fee-Based Account, N.Y. Times, Jan. 27, 2002, section 3, at 6; Sara 
Hansard, Demand for advice spurs switch to fees; Investors expect 
more than just stock tips, Inv. News, July 29, 2002, at 6.
    \7\ Because of these concerns, and because the rule provides an 
exception, the Commission believes that immediate effectiveness is 
appropriate. 5 U.S.C. 553(d).
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A. Temporary Rule

    Under temporary rule 202(a)(11)T, a broker-dealer providing 
investment advice to its brokerage customers is not required to treat 
those customers as advisory clients solely because of the form of the 
broker-dealer's compensation. The rule is available to any broker-
dealer registered under the Securities Exchange Act of 1934 \8\ that

[[Page 2713]]

satisfies two conditions: (i) The broker-dealer must not exercise 
investment discretion over the account from which it receives special 
compensation; and (ii) any investment advice must be solely incidental 
to the brokerage services provided to the account. The Companion 
Release sets out certain proposed interpretations of what services we 
view as solely incidental to brokerage and, as noted above, seeks 
comment on other issues related to this topic.
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    \8\ 15 U.S.C. 78(a) (``Exchange Act''). Unless otherwise noted, 
when we refer to the Exchange Act, or any paragraph of that Act, we 
are referring to 15 U.S.C. 78(a) of the United States Code in which 
the Exchange Act is published.
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    The temporary rule differs from the rule proposed in the Proposing 
Release in that the temporary rule does not include a requirement that 
broker-dealers disclose to customers that their accounts are brokerage 
accounts.\9\ We nevertheless encourage broker-dealers to make that 
disclosure.
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    \9\ The staff no-action position also was not conditioned on 
this disclosure.
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    The temporary rule will expire on April 15, 2005. The Commission 
intends to act on the proposal set forth in the Companion Release 
before that time. During the period of operation of the temporary rule, 
a broker-dealer receiving special compensation for advisory services 
provided to customers must satisfy each of the requirements of the 
temporary rule to avoid application of the Advisers Act. Unless another 
exception is available, the failure of a broker-dealer to meet any one 
of the requirements of the temporary rule will result in the loss of 
the exception, and the likely violation by the broker-dealer of one or 
more provisions of the Advisers Act.
    The temporary rule also contains a provision that a broker-dealer 
will 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.\10\ This provision is intended to keep 
a full-service broker-dealer from being subject to the Advisers Act 
solely because it also offers electronic trading or other forms of 
discount brokerage. Conversely, a discount broker will not be subject 
to the Act solely because it introduces a full-service brokerage 
program.
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    \10\ Rule 202(a)(11)T(a)(2).
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B. Scope of Exception

    A broker-dealer that is registered under the Exchange Act and 
registered under the Advisers Act is an investment adviser solely with 
respect to those accounts for which it provides services or receives 
compensation that subject the broker-dealer to the Advisers Act. This 
interpretation will continue to permit a broker-dealer registered under 
the Advisers Act to distinguish its brokerage customers from its 
advisory clients during the term of the temporary rule.\11\
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    \11\ Proposing Release, supra note 2. See also Final Extension 
of Temporary Rules, Investment Advisers Act Release No. 626 (Apr. 
27, 1978) [43 FR 19224 (May 4, 1978)].
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II. Cost Benefit Analysis

    The Commission is sensitive to the costs and benefits of its rules. 
Under the temporary rule, broker-dealers will not be deemed to be 
investment advisers with respect to accounts for which they receive 
asset-based fees, fixed fees, or similar non-commission compensation, 
provided that they do not exercise investment discretion over the 
account and their investment advice is solely incidental to the 
brokerage services provided to the account. The temporary rule also 
provides that broker-dealers are not subject to the Advisers Act solely 
because, in addition to full-service brokerage services, they also 
offer discount brokerage services, including execution-only brokerage, 
for reduced commission rates. These provisions of the temporary rule 
are designed to permit broker-dealers to continue to offer these fee-
based and discount brokerage programs without triggering regulation 
under the Advisers Act. As discussed above, the Commission is issuing 
the temporary rule to avoid disruption to broker-dealers who have begun 
offering these accounts after a staff no-action position relating to 
these accounts was announced in the Proposing Release in 1999. The 
temporary rule is effective until April 15, 2005. While the temporary 
rule is in place, the Commission will review the proposed exception and 
related issues set out in the Companion Release.
    The temporary rule imposes no costs. Broker-dealers will benefit 
from the temporary rule in the form of saved compliance costs they 
would otherwise expend on Advisers Act compliance with respect to 
accounts excepted from such compliance by the rule. In light of the 
Commission's issuance of the Companion Release requesting comment 
whether the exception should be incorporated into a permanent rule, 
these broker-dealers would face the choice whether to incur the costs 
of bringing these accounts into compliance with the Advisers Act now--
without knowing whether such costs will be avoidable in the near 
future--or terminating these fee arrangements with their existing 
customers. These customers will similarly benefit from not having their 
existing account arrangements disrupted pending the Commission's 
consideration of comments received on the Companion Release.

III. Effects on Competition, Efficiency and Capital Formation

    Section 202(c) of the Advisers Act mandates that the Commission, 
when engaging in rulemaking, consider whether an action is necessary or 
appropriate in the public interest, and to consider whether the action 
will promote efficiency, competition, and capital formation.\12\
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    \12\ 15 U.S.C. 80b-2(c).
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    As discussed above, rule 202(a)(11)T provides temporary relief from 
the Advisers Act to broker-dealers that offer certain fee-based 
brokerage programs or discount brokerage programs. Many broker-dealers 
have established these programs since 1999 when we issued our Proposing 
Release, which announced a staff no-action position relating to such 
programs.
    As a result of the adoption of this temporary rule, we note that 
the staff no-action position announced in the Proposing Release has 
terminated. In order to avoid disruption to broker-dealers offering 
these programs, and to their customers who invest through them, rule 
202(a)(11)T continues to except them under the Advisers Act until April 
15, 2005. Given the brief duration of the temporary rule, and the fact 
that it does not expand the capability of broker-dealers to offer fee-
based or discount brokerage programs, the temporary rule will have no 
effect on competition, efficiency, or capital formation.

IV. Paperwork Reduction Act

    The temporary rule contains no ``collection of information'' 
requirements within the meaning of the Paperwork Reduction Act of 
1995.\13\
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    \13\ 44 U.S.C. 3501 to 3520.
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V. Final Regulatory Flexibility Analysis

    The Commission proposed rule 202(a)(11)-1 under the Advisers Act in 
the Proposing Release.\14\ An Initial Regulatory Flexibility Analysis 
(``IRFA'') was published in the Proposing Release. No comments were 
received specifically on the IRFA. The Commission has prepared the 
following Final Regulatory Flexibility Analysis (``FRFA'') in 
accordance with 5 U.S.C. 604, regarding temporary rule 202(a)(11)T 
under the Advisers Act.
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    \14\ Proposing Release, supra note 2.

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A. Need for the Rule and Amendments

    Section I of this Release describes the reasons for and objectives 
of the temporary rule. As discussed in detail above, the temporary rule 
is designed to permit broker-dealers to continue to maintain, on an 
interim basis, fee-based and discount brokerage programs which they 
have established in increasing numbers since our issuance of the 
Proposing Release in 1999, which announced a staff no-action position 
relating to such accounts. The temporary rule is effective until April 
15, 2005, during which time the Commission will consider whether to 
adopt rules proposed in the Companion Release that would except these 
types of accounts, and related issues.

B. Significant Issues Raised by Public Comment

    The Commission received over 1,700 letters from commenters in 
response to the Proposing Release and a subsequent request for 
additional comments. Most commenters addressed provisions under 
proposed rule 202(a)(11)-1 pertaining to fee-based brokerage programs. 
Among those commenting on proposed rule 202(a)(11)-1, broker-dealers 
strongly supported it, while a large number of investment advisers and, 
in particular, financial planners, strongly opposed the proposal. The 
Commission specifically requested comments with respect to the IRFA, 
but did not receive any comments addressing the IRFA. The Commission 
did, however, receive a limited number of comments that discussed the 
effect proposed rule 202(a)(11)-1 might have on smaller broker-dealers, 
although these commenters did not address whether their comments 
pertained to entities that would be small businesses for purposes of 
Regulatory Flexibility Act analysis. These commenters argued that the 
inapplicability of the fee-based account exception to discretionary 
accounts disproportionately affects the competitiveness of certain 
smaller broker-dealers that assertedly rely on discretionary services 
to set themselves apart from larger broker-dealers.

C. Small Entities

    Temporary rule 202(a)(11)T under the Advisers Act applies to all 
brokers-dealers offering fee-based and discount brokerage programs on 
an interim basis that are registered with the Commission, including 
small entities. In developing the temporary rule we have considered its 
potential effect on small entities. Under Commission rules, for 
purposes of the Regulatory Flexibility Act, a broker-dealer 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.\15\
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    \15\ 17 CFR 240.0-10(c).
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    The Commission estimates that as of December 31, 2003, 
approximately 905 Commission-registered broker-dealers were small 
entities.\16\ The Commission is not aware of any small entities that 
are re-pricing their brokerage services in a manner that rule 
202(a)(11)T addresses, but assumes for purposes of this FRFA that all 
of these small entities could rely on the exception provided by the 
rule.
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    \16\ This estimate is based on the most recent information 
available, as 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. Projected Reporting, Recordkeeping, and Other Compliance 
Requirements

    The provisions of rule 202(a)(11)T, pertaining to the new types of 
brokerage accounts, impose no new reporting, recordkeeping, or 
compliance requirements. Rule 202(a)(11)T is designed to prevent 
regulatory burdens from being imposed on broker-dealers under the 
Advisers Act on an interim basis, pending the Commission's 
consideration of the exception in the Companion Release.

E. Agency Action To Minimize Effect on Small Entities

    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.\17\ 
In connection with the temporary rule the Commission considered the 
following alternatives: (a) The use of performance rather than design 
standards; and (b) an exemption from coverage of the rule, or any part 
thereof, for such small entities.\18\
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    \17\ 5 U.S.C. 603(c).
    \18\ Rule 202(a)(11)T does not contain any reporting, 
recordkeeping, or compliance requirements. Accordingly, the 
Commission did not consider (a) the establishment of differing 
compliance or reporting requirements or timetables that take into 
account the resources available to small entities; or (b) the 
clarification, consolidation, or simplification of compliance and 
reporting requirements under the rule for such small entities.
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    With respect to the first alternative, the Commission believes that 
the compliance requirements contained in the temporary rule already 
appropriately use performance standards instead of design standards. 
The temporary rule is crafted to make regulation under the Advisers Act 
turn on the nature of the services performed by a broker-dealer rather 
than on the type of compensation involved. Thus, eligibility for the 
rule's exception hinges on the services performed by the broker-dealer.
    With respect to the second alternative, the Commission believes 
that exempting small entities would be inappropriate. To the extent 
rule 202(a)(11)T allows broker-dealers to avoid regulatory burdens that 
might otherwise be imposed on broker-dealers during the Commission's 
consideration of comments received on the Companion Release, small 
entities, as well as large entities, will benefit from the rule. Small 
broker-dealers should be permitted to enjoy this benefit to the same 
extent as larger broker-dealers. The Commission also believes that 
commenters' suggestions to exempt small entities from one of the 
conditions for applicability of the fee-based account exception--that 
the broker-dealer not exercise investment discretion over the account--
would be inconsistent with the Commission's objectives under the 
temporary rule.

VI. Statutory Authority

    Our authority to adopt the temporary rule is based on section 
202(a)(11)(F) of the Advisers Act, which expressly allows the 
Commission to except persons--in addition to those already excepted by 
sections 202(a)(11)(A)-(E)--that the definition of investment adviser 
was not intended to cover.\19\ We are also acting pursuant to section 
211(a) of the Advisers Act, which gives us the 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. 
Additionally, section 206A of the Advisers Act gives us the authority, 
by rules and regulations, to exempt any person or transaction, or any 
class or classes of persons or transactions, from any provision or 
provisions of the Act or of any rule or regulation thereunder, if such 
exemption is necessary or appropriate in the public interest and

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consistent with the protection of investors and the purposes of the 
Act.
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    \19\ Because we are using our authority under section 
202(a)(11)(F), broker-dealers relying on the temporary rule would 
not be subject to state adviser statutes. Section 203A(b)(1)(B) of 
the Advisers Act 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 Part 275

    Investment advisers, Reporting and recordkeeping requirements.

Text of Rule

0
For the reasons set out in the preamble, Title 17, Chapter II of the 
Code of Federal Regulations is amended as follows:

PART 275--RULES AND REGULATIONS, INVESTMENT ADVISERS ACT OF 1940

0
1. The authority citation for Part 275 continues to read in part as 
follows:

    Authority: 15 U.S.C. 80b-2(a)(11)(F), 80b-2(a)(17), 80b-3, 80b-
4, 80b-4a, 80b-6(4), 80b-6a, and 80b-11, unless otherwise noted.
* * * * *

0
2. Section 275.202(a)(11)T is added to read as follows:


Sec.  275.202(a)(11)T  Temporary rule regarding certain broker-dealers.

    (a) A broker or dealer registered with the Commission under section 
15 of the Securities Exchange Act of 1934 (15 U.S.C. 78a) (the 
``Exchange Act''):
    (1) Will not be deemed to be an investment adviser based solely on 
its receipt of special compensation, provided that:
    (i) 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 accounts from which it receives special 
compensation; and
    (ii) 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
    (2) 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.
    (b) A broker or dealer registered with the Commission under section 
15 of the Exchange Act 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 Advisers Act.
    (c) This temporary section shall expire on April 15, 2005.

    By the Commission.
    Dated: January 6, 2005.
J. Lynn Taylor,
Assistant Secretary.
[FR Doc. 05-602 Filed 1-13-05; 8:45 am]
BILLING CODE 8010-01-P