[Federal Register Volume 70, Number 74 (Tuesday, April 19, 2005)]
[Rules and Regulations]
[Pages 20424-20454]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 05-7641]



[[Page 20423]]

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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; Final Rule

  Federal Register / Vol. 70, No. 74 / Tuesday, April 19, 2005 / Rules 
and Regulations  

[[Page 20424]]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 275

[Release Nos. 34-51523; IA-2376; File No. S7-25-99]
RIN 3235-AH78


Certain Broker-Dealers Deemed Not To Be Investment Advisers

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: The Securities and Exchange Commission is adopting a 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 advice that is solely incidental to its 
brokerage services is excepted from the Advisers Act if it charges an 
asset-based or fixed fee (rather than a commission, mark-up, or mark-
down) for its services, provided it makes certain disclosures about the 
nature of its services. The rule states that exercising investment 
discretion is not ``solely incidental to'' the business of a broker or 
dealer within the meaning of the Advisers Act or to brokerage services 
within the meaning of the rule. The rule also states that a broker or 
dealer provides investment advice that is not solely incidental to the 
conduct of its business as a broker or dealer or to its brokerage 
services if the broker or dealer charges a separate fee or separately 
contracts for advisory services. In addition, the rule states that when 
a broker-dealer provides advice as part of a financial plan or in 
connection with providing planning services, a broker-dealer provides 
advice that is not solely incidental if it: holds itself out to the 
public as a financial planner or as providing financial planning 
services; or delivers to its customer a financial plan; or represents 
to the customer that the advice is provided as part of a financial plan 
or financial planning services. Finally, under the rule, broker-dealers 
are not subject to the Advisers Act solely because they offer full-
service brokerage and discount brokerage services (including electronic 
brokerage) for reduced commission rates.

DATES: Effective date: April 15, 2005, except that 17 CFR 
275.202(a)(11)-1(a)(1)(ii) is effective May 23, 2005. Compliance dates: 
see Section IV of this Release.

FOR FURTHER INFORMATION CONTACT: Robert L. Tuleya, Senior Counsel, or 
Nancy M. Morris, Attorney-Fellow, at 202-551-6787, [email protected], 
Office of Investment Adviser Regulation, Division of Investment 
Management, Securities and Exchange Commission, 450 Fifth Street, NW, 
Washington, DC 20549-0506.

SUPPLEMENTARY INFORMATION: The Securities and Exchange Commission 
(``Commission'' or ``SEC'') is adopting new rule 202(a)(11)-1\1\ under 
the Investment Advisers Act of 1940 (``Advisers Act'' or ``Act'').\2\
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    \1\ 17 CFR 275.202(a)(11)-1. When we refer to rule 202(a)(11)-1 
or any paragraph in that rule, we are referring to 17 CFR 
275.202(a)(11)-1 where it is published in the Code of Federal 
Regulations.
    \2\ 15 U.S.C. 80b-1. 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. Introduction
II. Background
    A. The Advisers Act Broker-Dealer Exception
    B. The Current Rulemaking
    1. The 1999 Proposal
    2. The Reproposal
III. Discussion
    A. Fee-Based Brokerage Programs
    1. Historical Context
    2. Our Conclusions
    B. Exception for Fee-Based Brokerage Accounts
    1. Solely Incidental To
    2. Customer Disclosure
    C. Discount Brokerage Programs
    D. Scope of Exception
    E. Solely Incidental To
    1. Separate Contract or Fee
    2. Financial Planning
    3. Holding Out
    4. Discretionary Asset Management
    5. Wrap Fee Sponsorship
IV. Effective and Compliance Dates
V. Further Examination of Issues
VI. Cost-Benefit Analysis
VII. Effects of Competition, Efficiency and Capital Formation
VIII. Paperwork Reduction Act
IX. Regulatory Flexibility Analysis
X. Statutory Authority
Text of Rule

I. Introduction

    This rulemaking addresses the question of when the investment 
advisory activities of a broker-dealer subject it to the Advisers Act. 
The activities of broker-dealers are regulated primarily under the 
Securities Exchange Act of 1934 \3\ and by the self-regulatory 
organizations (``SROs''). The activities of investment advisers are 
regulated primarily under the Advisers Act.
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    \3\ 15 US.C. 78a (``Exchange Act'').
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    The Advisers Act and the Exchange Act are not exclusive in their 
application to advisers and broker-dealers, respectively. Many broker-
dealers are also registered with us as advisers because of the nature 
of the services they provide or the form of compensation they receive. 
Until recently, the division between broker-dealers and investment 
advisers was fairly clear, and the regulatory obligations of each 
fairly distinct. Of late, however, the distinctions have begun to blur, 
raising difficult questions regarding the application of statutory 
provisions written by Congress more than half a century ago.
    Our efforts to address this question, which began in 1999, have 
prompted substantial interest from advisers and broker-dealers as well 
as groups representing the interests of investors. We very much 
appreciate the efforts of these groups in commenting on our proposal, 
meeting with us and our staff, and offering their many suggestions. The 
evolution of our thinking about these questions, and the important 
contribution these commenters have made to that evolution, is 
demonstrated in the rule we are today adopting.
    Although many commenters urge that all who render investment advice 
must be regulated as advisers, Congress created a different scheme of 
regulation--one that excepted many who provide investment advice, 
including many broker-dealers registered under the Exchange Act, from 
the Advisers Act. As a consequence, many of the concerns about broker-
dealer conduct voiced in the course of this rulemaking may be more 
appropriately addressed under the Exchange Act. Although we share the 
concern that there is confusion about the differences between broker-
dealers and investment advisers, and although we believe that some of 
that confusion may be a result of broker-dealer marketing (including 
the titles broker-dealers use), we do not believe that this confusion 
arises as a result of this rulemaking or that it is confined to the new 
programs addressed by this rulemaking. Indeed, to a large extent, this 
rulemaking does address confusion in the context of the brokerage 
programs addressed here. Again, however, we believe that many of these 
concerns may more appropriately fall under broker-dealer regulation 
and, as stated below, the Chairman has directed our staff to determine 
and report to us within 90 days the options for most effectively 
responding to these issues and a recommended course of action. This 
schedule reflects both our appreciation of the significance of these 
concerns and our determination to pursue an appropriate and effective 
solution.
    We begin with a discussion of the relevant provisions of the 
Advisers Act and the changes in brokerage services that raise these 
vexing issues. Finally, and before describing the rule we are

[[Page 20425]]

today adopting, we review the history of this rulemaking and the 
evolution of our thinking on this subject.

II. Background

A. The Advisers Act Broker-Dealer Exception

    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.\4\ 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.'' The broker-dealer exception thus has two prongs, both of 
which a broker-dealer must meet in order to avoid application of the 
Act: (i) The broker-dealer's advisory services must be ``solely 
incidental to'' its brokerage business; and (ii) the broker-dealer must 
receive no ``special compensation'' for the advice. The Advisers Act 
defines neither of the quoted phrases, and the Act's legislative 
history offers limited explanation of them. We (and our staff) have 
stated our views of what the phrases mean in several releases we have 
issued over the years. One of the earliest of these releases explained 
that 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.'' \5\
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    \4\ For a discussion of the scope of the Advisers Act, see 
Applicability of the Investment Advisers Act to Financial Planners, 
Pension Consultants, and Other Persons Who Provide Investment 
Advisory Services as a Component of Other Financial Services, 
Investment Advisers Act Release No. 1092 (Oct. 8, 1987) [52 FR 38400 
(Oct. 16, 1987)] (``Advisers Act Release No. 1092'').
    \5\ See Opinion of the 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 (Sept. 27, 
1946)] (``Advisers Act Release No. 2'').
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    As we noted above, many broker-dealers are also registered as 
advisers. We have viewed the Advisers Act, and the protections afforded 
by the Act, as applying only to those accounts to which the broker-
dealer provides investment advice that is not solely incidental to 
brokerage services or for which the firm receives special 
compensation.\6\ For these firms, the issues raised in this rulemaking 
relate not to whether the firm is subject to the Advisers Act, but to 
which of its accounts must be treated as advisory accounts.
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    \6\ Certain Broker-Dealers Deemed Not to be Investment Advisers, 
Investment Advisers Act Release No. 2340 (Jan. 6, 2005) [70 FR 2716 
(Jan. 14, 2005)] (``Reproposing Release'' or ``Reproposal''); 
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'' or ``1999 Proposal''). Cf. 
Final Extension of Temporary Rules, Investment Advisers Act Release 
No. 626 (Apr. 27, 1978) [43 FR 19224 (May 4, 1978)] (``Advisers Act 
Release No. 626'').
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B. The Current Rulemaking

1. The 1999 Proposal
    This rulemaking began on November 4, 1999, when we first proposed 
new rule 202(a)(11)-1.\7\ Our 1999 Proposal responded to the 
introduction of two new types of brokerage programs--``fee-based 
brokerage programs'' and ``discount brokerage programs'' \8\--that 
full-service broker-dealers were offering in response to changes in the 
market place for retail brokerage.\9\ The 1999 Proposal addressed 
whether, as a result of introducing these programs, broker-dealers 
would be unable to rely on the broker-dealer exception in the Advisers 
Act. If so, some broker-dealers would be required to register under the 
Act, and those already registered would be required to treat customers 
with such accounts as advisory clients rather than brokerage customers.
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    \7\ Proposing Release, supra note 6.
    \8\ Proposing Release, supra note 6. 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 referenced in this Release.
    \9\ See Patrick McGeehan, The Media Business: Advertising, 
Schwab Takes Another Kind of Swipe at the Big Wall Street Firms in a 
New Campaign, N.Y. Times, Aug. 28, 2000, at C11; Jack White and Doug 
Ramsey, A Belle Epoque for Wall Street, Barron's, Oct. 18, 1999, at 
54; John Steele Gordon, Manager's Journal: Merrill Lynch Once Led 
Wall Street. Now It's Catching Up, Wall St. J., June 14, 1999, at 
A20.
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    Fee-based brokerage programs provide customers a package of 
brokerage services--typically including execution, investment advice, 
arranging for delivery and payment, and custodial and recordkeeping 
services--for a fee based on the amount of assets on account with the 
broker-dealer (i.e., an asset-based fee) or a fixed-fee. A broker-
dealer receiving such fee-based compensation may be unable to rely on 
the statutory broker-dealer exception because the fee constitutes 
``special compensation'' under the Act--i.e., it involves the receipt 
by a broker-dealer of compensation other than brokerage commissions or 
dealer compensation (i.e., mark-ups, mark-downs, or similar fees).\10\
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    \10\ See S. Rep. No. 76-1775, 76th Cong., 3d Sess. 22 (1940) 
(``S. Rep. No. 76-1775'') (section 202(a)(11)(C) of the Advisers Act 
applies to broker-dealers ``insofar as their advice is merely 
incidental to brokerage transactions for which they receive only 
brokerage commissions.'') (emphasis added). See also Disclosure by 
Investment Advisers Regarding Wrap Fee Programs, Investment Advisers 
Act Release No. 1401 (Jan. 13, 1994) at n.2. Our references in this 
Release to ``commission-based brokerage'' include transactions 
effected on a principal basis for which the broker-dealer is 
compensated by a mark-up or mark-down.
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    Discount brokerage programs, including electronic trading programs, 
give customers who do not want or need advice from brokerage firms the 
ability to trade securities at a lower commission rate. Electronic 
trading programs provide customers the ability to trade on-line, 
typically without the assistance of a registered representative, from 
any personal computer connected to the Internet. Customers trading 
electronically may devise their own investment or trading strategies, 
or may seek advice separately from investment advisers. The 
introduction of electronic trading and other discount services at a 
lower commission rate may trigger application of the Advisers Act to 
any full-service accounts for which the broker-dealer provides some 
investment advice. This is because the difference in the commission 
rates represents a clearly definable portion of the brokerage 
commission that may be primarily attributable to investment advice. Our 
staff has viewed such a two-tiered fee structure as involving ``special 
compensation'' under the Advisers Act.\11\
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    \11\ Advisers Act Release No. 626, supra note 6; Advisers Act 
Release No. 2, supra note 5; Robert S. Strevell, SEC Staff No-Action 
Letter (Apr. 29, 1985)(``Strevell No-Action Letter'')(``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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    Fee-based brokerage programs responded to 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.\12\ We were troubled that

[[Page 20426]]

application of the Advisers Act to broker-dealers offering these new 
brokerage programs would discourage their development, which we viewed 
as potentially providing benefits to brokerage customers. After 
reviewing these new fee-based brokerage programs, we concluded that 
they were not fundamentally different from traditional brokerage 
programs. We viewed broker-dealers offering these new programs as 
having re-priced traditional brokerage programs rather than as having 
created advisory programs. We proposed rule 202(a)(11)-1 because we 
believed that Congress could not have intended to subject full-service 
broker-dealers offering these programs to the Advisers Act when, in 
conducting these programs, broker-dealers offer advice as part of a 
traditional package of brokerage services.\13\
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    \12\ These concerns led to the formation of a broad-based 
committee whose mandate was to identify conflicts of interest in 
brokerage industry compensation practices and ``best'' practices in 
compensating registered representatives. The committee was formed in 
1994 at the suggestion of then Commission Chairman Arthur Levin. The 
committee found that fee-based compensation would better align the 
interests of broker-dealers and their clients and allow registered 
representatives to focus on what the committee described as their 
most important role--providing investment advice to individual 
clients, not generating transaction revenues. See Report of the 
Committee on Compensation Practices (Apr. 10, 1995) (``Tully 
Report'').
    \13\ See infra notes 41-50 and accompanying text (discussing 
``traditional brokerage services''). We did not then, nor do we now, 
intend to suggest that brokerage services (including advice) have 
remained advice) have remained static throughout the years. We 
simply conclude that the broad services we identify as part of the 
package of traditional brokerage services have not changed.
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    Under the 1999 Proposal, a broker-dealer providing investment 
advice to customers would be excluded from the definition of investment 
adviser regardless of the form that its compensation takes 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. These provisions of the proposed rule were designed 
to make application of the Advisers Act turn more on the nature of the 
services provided by the broker-dealer than on the form of 
compensation. In addition, we proposed that a broker or dealer would 
not be deemed to have received special compensation solely because the 
broker or dealer charges one customer a commission, mark-up, mark-down, 
or similar fee for brokerage services, that is greater than or less 
than one it charges another customer. This provision was designed to 
permit full-service broker-dealers to offer discount brokerage, 
including electronic trading, without having to treat full-price, full-
service brokerage customers as advisory clients.\14\
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    \14\ See supra note 11 and accompanying text.
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    We received over 1700 comment letters on the 1999 Proposal, most of 
which addressed only the rule provisions concerning fee-based brokerage 
programs.\15\ Generally, broker-dealers commenting on the proposed rule 
strongly supported it,\16\ asserting that fee-based brokerage programs 
benefited customers by aligning the interests of representatives with 
those of their customers.\17\ The application of the Advisers Act, 
broker-dealers argued, would discourage the introduction of fee-based 
programs by imposing a duplicative and unnecessary regulatory 
regime.\18\
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    \15\ Twenty-five letters were submitted during the comment 
period for the 1999 Proposal. Following the close of the comment 
period, however, we received hundreds more letters. In view of 
ongoing and significant public interest in the Proposal, and in 
order to provide all persons who were interested in this matter a 
current opportunity to comment, we reopened the period for public 
comment on the 1999 Proposal in August 2004. Investment Advisers Act 
Release No. 2278 (Aug. 18, 2004) [69 FR 51620 (Aug. 20, 2004)]. The 
reopened comment period closed on September 22, 2004. Comment 
letters received throughout this rulemaking 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).
    \16\ See, e.g., Comment Letter of Merrill, Lynch, Pierce, Fenner 
& Smith Incorporated (Sept. 22, 2004) (``Merrill Lynch Sept. 22, 
2004 Letter''); Comment Letter of Raymond James Financial, Inc. 
(Sept. 21, 2004); Comment Letter of Northwestern Mutual Investment 
Services, LLC (Sept. 22, 2004); Comment Letter of Smith Barney 
Citigroup (Jan. 14, 2000). See also Comment letter of Securities 
Industry Association (Sept. 22, 2004) (``SIA Sept. 22, 2004 
Letter'').
    \17\ See, e.g., Comment Letter of Citigroup Global Markets Inc. 
(Sept. 22, 2004) (``CGMI Sept. 22, 2004 Letter''); Comment Letter of 
Charles Schwab & Co. (Sept. 22, 2004) (``Charles Schwab Sept. 22, 
2004 Letter''); Comment Letter of Securities Industry Association 
(Sept. 13, 2000) (``SIA Sept. 13, 2000 Letter''); Comment Letter of 
Securities Industry Association (Aug. 5, 2004).
    \18\ See, e.g., CGMI Sept. 22, 2004 Letter, supra note 17, 
Merrill Lynch Sept. 22, 2004 Letter, supra note 16; SIA Jan. 13, 
2000 Letter, supra note 17.
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    A large number of investment advisers--in particular, financial 
planners--and several groups representing investor interests--submitted 
letters strongly opposed to the proposed rule.\19\ Some of these 
commenters took issue with our conclusions that the new programs do not 
differ fundamentally from traditional brokerage programs.\20\ Many of 
these commenters asserted that adoption of the rule would deny 
investors important protections provided by the Advisers Act, in 
particular, the fiduciary duties and disclosure obligations to which 
advisers are held.\21\ Another theme among some opponents of the rule 
was the competitive implications for financial planners, who would 
generally be subject to the Act, while broker-dealers would not.\22\ 
Many commenters focused on whether and when advisory services can be 
considered ``solely incidental to'' brokerage and urged us to provide 
guidance on the meaning of the phrase.\23\
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    \19\ See, e.g., Comment Letter of Carl Kunhardt (Dec. 28, 1999); 
Comment Letter of Pamela A. Jones (Jan. 4, 2000); Comment Letter of 
Investment Counsel Association of America (Jan. 12, 2000) (``ICAA 
Jan. 12, 2000 Letter'') (representing SEC-registered investment 
advisers); Comment Letter of Consumer Federation of America (Jan. 
13, 2000) (``CFA Jan. 13, 2000 Letter''); Comment Letter of The 
Financial Planning Association (Jan. 14, 2000) (``FPA Jan. 14, 2000 
Letter''); Comment Letter of AARP (Nov. 17, 2003); Comment Letter of 
PFPG Fee-Only Advisors (June 21, 2004); Comment Letter of Timothy M. 
Montague (Sept. 10, 2004); Comment Letter of William S. Hrank (Sept. 
20, 2004); Comment Letter of Marilyn C. Dimitroff (Sept. 21, 2004).
    \20\ See, e.g., Comment Letter of Arthur V. von der Linden (May 
10, 2000); CFA Jan. 13, 2000 Letter, supra note 19; FPA Jan. 14, 
2000 Letter, supra note 19; ICAA Jan. 12, 2000 Letter, supra note 
19.
    \21\ See, e.g., Comment Letter of American Institute of 
Certified Public Accountants (Sept. 22, 2004) (``AICPA Sept. 22, 
2004 Letter''); CFA Jan. 13, 2000 Letter, supra note 19; FPA Jan. 
14, 2000 Letter, supra note 19.
    \22\ See, e.g., Comment Letter of Dan Jamieson (June 1, 2000); 
Comment Letter of Joel P. Bruckenstein (May 31, 2000); Comment 
Letter of Margaret Lofaro (May 8, 2000); Comment Letter of Shawnee 
Barbour (Sept. 13, 2004); Comment Letter of Roselyn Wilkinson (Sept. 
13, 2004); Comment Letter of Robert J. Lindner (Sept. 14, 2004); 
Comment Letter of Robert Lawson (Sept. 16, 2004); Comment Letter of 
Linda Patchett (Sept. 20, 2004); Comment Letter of John Ellison 
(Sept. 20, 2004); Comment Letter of Connie Brezik (Sept. 18, 2004); 
Comment Letter of Keven M. Doll (Sept. 20, 2004); Comment Letter of 
Phoebe M. White (Sept. 20, 2004); Comment Letter of Eric G. Shisler 
(Sept. 20, 2004); Comment Letter of Jami M. Thornton (Sept. 20, 
2004); see also Comment Letter of Consumer Federation of America 
(Feb. 28, 2000) (``CFA Feb. 28, 2000 Letter'').
    \23\ AICPA Sept. 22, 2004 Letter, supra note 21; Comment Letter 
of The Financial Planning Association (June 21, 2004); Comment 
Letter of Consumer Federation of America (Nov. 4, 2004); ICAA Jan. 
12, 2000 Letter, supra note 19.
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    The many comments we received caused us to reconsider our proposed 
rule. We decided to repropose the rule with some modifications, 
reflecting the thoughtful comments we received, and sought comment on 
our Reproposal.\24\
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    \24\ Reproposing Release, supra note 6. In a companion release 
issued on the same day, the Commission adopted a temporary rule 
under which a broker-dealer providing non-discretionary advice to 
customers would be excluded from the definition of investment 
adviser under the Advisers Act regardless of its form its 
compensation takes, as long as the advice is solely incidental to 
its brokerage services. Investment Advisers Act Release No. 2339 
(Jan. 6, 2005) [70 FR 2712 (Jan. 14, 2005)]. The temporary rule 
expires on April 15, 2005.
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2. The Reproposal
    In January we published a release in which we affirmed the basic 
approach of the 1999 Proposal.\25\ Like our 1999 Proposal, our 
reproposed rule would deem a broker-dealer registered under

[[Page 20427]]

the Exchange Act not to be an investment adviser solely as a result of 
receiving special compensation if the securities advice given to 
customers is provided on a non-discretionary basis, and it is solely 
incidental to the brokerage services provided to the customers, 
provided certain disclosure is made. We did, however, propose some 
significant changes in response to comments we received on the 1999 
Proposal.
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    \25\ Reproposing Release, supra note 6.
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    First, we proposed expanded disclosure to address many commenters' 
concerns that investors were confused about the differences between 
brokers and advisers. As reproposed, the rule would require that all 
advertisements for, and all agreements, contracts, applications and 
other forms governing the operation of, a fee-based brokerage account 
contain a prominent statement that the account is a brokerage account 
and not an advisory account. In addition, the disclosure would have to 
explain that, as a consequence, the customer's rights and the firm's 
duties and obligations to the customer, including the scope of the 
firm's fiduciary obligations, may differ. Finally, broker-dealers would 
have to identify an appropriate person at the firm with whom the 
customer could discuss those differences.
    Second, we responded to concerns that commenters raised about the 
lack of guidance as to when the advisory services of broker-dealers 
were not solely incidental to their brokerage activities. We included 
in the Reproposing Release a proposed statement of interpretive 
position under which investment advice would be ``solely incidental 
to'' brokerage services provided to an account when those advisory 
services are in connection with and reasonably related to the brokerage 
services. The proposed interpretation provided that, under certain 
circumstances, financial planning services would not be solely 
incidental to the business of brokerage. Finally, we proposed to add a 
provision to rule 202(a)(11)-1 interpreting a broker-dealer's exercise 
of investment discretion on behalf of a customer as providing advice 
that is not solely incidental to its business as a broker.
    We received over 300 comment letters on the reproposed rule. Many 
commenters, including most financial planners, strongly objected to the 
rule. They viewed fee-based brokerage accounts as advisory accounts, 
and urged that they be regulated as such under the Advisers Act.\26\ 
Many urged that broker-dealers be subject to the Advisers Act whenever 
they provide investment advice.\27\ Others urged us to adopt a narrow 
interpretation of ``solely incidental to'' under which many more 
activities (and customer accounts) of broker-dealers would be subject 
to the Advisers Act.\28\ Broker-dealers strongly supported the rule for 
many of the same reasons they supported the 1999 Proposal.\29\ Most, 
but not all, however, objected to our proposed interpretation that 
would require them to treat financial planning customers as advisory 
clients.\30\
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    \26\ See, e.g., Comment Letter of Richard L. Cox (Jan. 6, 2005) 
(``Cox Letter''); Comment Letter of Bill McDonald (Jan. 14, 2005); 
Comment Letter of Timothy F. Bock (Jan. 6, 2005); Comment Letter of 
Harry Scheyer (Jan. 15, 2005); Comment Letter of William M. Harris 
(Jan. 16, 2005); Comment Letter of Colin S. Mackenzie (Jan. 17, 
2005); Comment Letter of James L. Gruning (Jan. 17, 2005); Comment 
Letter of Roy L. Komack (Feb. 5, 2005); Comment Letter of Terry P. 
Welsh (Feb. 7, 2005); Comment Letter of Leon Morris (Feb. 9, 2005).
    \27\ See, e.g., Comment Letter of Stephanie Berger (Jan. 7, 
2005); Comment Letter of Mote Wealth Management (Jan. 11, 2005); 
Comment Letter of Donny E. Long (Jan. 12, 2005); Comment Letter of 
Mark Greenberg (Jan. 14, 2005); Comment Letter of Kelly F. Crane 
(Jan. 14, 2005); Comment Letter of William B. Burns, Jr. (Jan. 14, 
2005); Comment Letter of Randy Gerard (Jan. 17, 2005); Comment 
Letter of Margery K. Schiller (Jan. 18, 2005); Comment Letter of 
Michael J. Zmistowski (Jan. 18, 2005); Comment Letter of Glencrest 
Investment Advisors (Jan. 20, 2005); Comment Letter of Evensky & 
Katz (Feb. 3, 2005); Comment Letter of Financial Planning 
Association (Feb. 7, 2005) (``FPA Letter''); Comment Letter of John 
K. Ritter (Feb. 7, 2005); Comment Letter of Thomas M. Wargin (Feb. 
7, 2005). See also Comment Letter of International Association of 
Registered Financial Consultants (Jan. 4, 2005).
    \28\ See, e.g., Comment Letter of Michael Boyd (Jan. 11, 2005) 
(``Boyd Letter''); Comment Letter of Michael O. Babin (Jan. 17, 
2005); Comment Letter of Daniel H. Boyce (Jan. 18, 2005); Comment 
Letter of Certified Financial Planner Board of Standards (Feb. 6, 
2005) (``CFP Board Letter''); Comment Letter of Consumer Federation 
of America (Feb. 7, 2005) (``CFA Letter''); Comment Letter of Fund 
Democracy, Consumer Federation of America, Consumers Union, Consumer 
Action (Feb. 7, 2005) (``Joint Letter of Fund Democracy et al.''); 
Investment Counsel Association of America (Feb. 7, 2005) (``ICAA 
Letter''); Comment Letter of T. Rowe Price Associates (Feb. 22, 
2005) (``T. Rowe Price Letter''); Comment Letter of AARP (Mar. 9, 
2005) (``AARP Letter'').
    \29\ See, e.g., Comment Letter of Merrill, Lynch, Pierce, Fenner 
& Smith (Feb. 7, 2005) (``Merrill Lynch Letter''); Comment Letter of 
Raymond James & Associates, Inc. (Feb. 7, 2005) (``Raymond James 
Letter''); Comment Letter of Citigroup Global Markets Inc. (``CGMI 
Letter''); Comment Letter of Morgan Stanley (Feb. 7, 2005) (``Morgan 
Stanley Letter''); Comment Letter of Northwestern Mutual Investment 
Services, LLC (Feb. 7, 2005) (``Northwestern Mutual Letter''); 
Comment Letter of UBS Financial Services, Inc. (Feb. 7, 2005) (``UBS 
Letter''); Comment Letter of Wachovia Securities, LLC (Feb. 7, 2005) 
(``Wachovia Letter''). See also Comment Letter of Securities 
Industry Association (Feb. 7, 2005) (``SIA Letter''); Comment Letter 
of National Association of Securities Dealers (Feb. 11, 2005) 
(``NASD Letter'').
    \30\ See, e.g., Merrill Lynch Letter, supra note 29; Raymond 
James Letter, supra note 29; CGMI Letter, supra note 29; Morgan 
Stanley Letter, supra note 29; Northwestern Mutual Letter, supra 
note 29; SIA Letter, supra note 29; UBS Letter, supra note 29; 
Wachovia Letter, supra note 29.
---------------------------------------------------------------------------

III. Discussion

    We are today adopting new rule 202(a)(11)-1 under the Advisers Act 
for the reasons discussed below and in this rulemaking record. The rule 
is designed to avoid application of the Advisers Act to broker-dealers 
merely because they re-price their full-service brokerage or provide 
execution-only or similar discount brokerage services in addition to 
full-service brokerage. As discussed in more detail below, we believe 
the rule draws an appropriate line as to when a broker-dealer's 
advisory activities trigger application of the Advisers Act.

A. Fee-Based Brokerage Programs

    Commenters on the Reproposal viewed these new fee-based brokerage 
accounts through entirely different prisms and came to entirely 
different conclusions. Some saw the introduction of fee-based brokerage 
programs as a significant migration from a brokerage relationship to an 
advisory relationship.\31\ They urged, therefore, that we treat all 
fee-based brokerage accounts as advisory accounts.\32\ Broker-dealers, 
on the other hand, viewed the new fee-based programs as providing the 
same services, including investment advice, that they have 
traditionally provided to customers.\33\ They did not

[[Page 20428]]

view the change in pricing as significant except insofar as it better 
aligns the interests of registered representatives with those of their 
customers.\34\
---------------------------------------------------------------------------

    \31\ See, e.g., Cox Letter, supra note 26; Comment Letter of 
Public Investors Arbitration Bar Association (Feb. 4, 2005) (``PIABA 
Letter''); FPA Letter, supra note 27; Joint Letter of Fund Democracy 
et al., supra note 28; Comment Letter of National Association of 
Personal Financial Advisors (Feb. 7, 2005) (``NAPFA Letter''); 
Comment Letter of American Institute of Certified Public Accountants 
(Feb. 7, 2005) (``AICPA Letter''). See also Comment Letter of 
Federated Investors, Inc. (Jan. 14, 2000) (``Federated Letter''); 
ICAA Jan. 12, 2000 Letter, supra note 19; CFA Feb. 28, 2000 Letter, 
supra note 22; FPA Jan. 14, 2000 Letter, supra note 19; Comment 
Letter of Joseph Capital Management, LLC (Aug. 30, 2004); Comment 
Letter of Jared W. Jameson (Sept. 16, 2004); Comment Letter of 
Geoffrey F. Fosie (Sept. 22, 2004); Comment Letter of the Foundation 
for Fiduciary Studies (Sept. 12, 2004).
    \32\ See, e.g., Cox Letter, supra note 26; Comment Letter of 
Anna M. Taglieri (Jan. 9, 2005); Comment Letter of Harrod Financial 
Planning (Jan. 14, 2005); PIABA Letter, supra note 31; FPA Letter, 
supra note 27; Joint Letter of Fund Democracy et al., supra note 28; 
NAPFA Letter, supra note 31; AICPA Letter, supra note 31. See also 
Comment Letter of Roy T. Diliberto (Aug. 24, 2004); Comment Letter 
of Don B. Akridge (Sept. 7, 2004); Comment Letter of William K. Dix, 
Jr. (Sept. 21, 2004) (``Dix Letter''); CFA Jan. 13, 2000 Letter, 
supra note 19.
    \33\ See, e.g., Merrill Lynch Letter, supra note 29; Morgan 
Stanley Letter, supra note 29; Wachovia Letter, supra note 29; NASD 
Letter, supra note 29; Comment Letter of American Express Financial 
Advisers, Inc. (Mar. 4, 2005) (``American Express Letter''). See 
also Comment Letter of Paine Webber Incorporated (Jan. 14, 2000); 
Comment Letter of U.S. Bancorp Piper Jaffray Inc. (Jan. 19, 2000) 
(``U.S. Bancorp Jan. 19, 2000 Letter''); Comment Letter of 
Prudential Securities Incorporated (Jan. 31, 2000) (``Prudential 
Jan. 31, 2000 Letter''); Merrill Lynch Sept. 22, 2004 Letter, supra 
note 16.
    \34\ See, e.g., Merrill Lynch Letter, supra note 29; American 
Express Letter, supra note 33. See also U.S. Bancorp Jan. 19, 2000 
Letter, supra note 33; Prudential Jan. 31, 2000 Letter, supra note 
33; CGMI Sept. 22, 2004 Letter, supra note 17; Merrill Lynch Sept. 
22, 2004 Letter, supra note 16; SIA Sept. 22, 2004 Letter, supra 
note 16.
---------------------------------------------------------------------------

    In order to explain how we have resolved the issues on which the 
commenters disagree, and consistent with our authority in the Advisers 
Act,\35\ we consider Congress' intent in defining the scope of the Act. 
We first review the historical context in which Congress passed the 
Advisers Act, including the broker-dealer exception, in 1940.\36\
---------------------------------------------------------------------------

    \35\ Section 202(a)(11)(F) excludes from the definition of 
investment adviser, and thus the Act, ``such other persons not 
within the intent of this paragraph, as the Commission may designate 
by rules and regulations or order.'' See also Section X of this 
Release, infra.
    \36\ In the Reproposing Release, we solicited comments on our 
reading of the history and background of the Act and, in particular, 
the broker-dealer exception. Some commenters agreed with our reading 
(see, e.g., SIA Letter, supra note 29) and others did not (see, 
e.g., CFA Letter, supra note 28; Joint Letter of Fund Democracy et 
al., supra note 28; FPA Letter, supra note 27; Comment Letter of 
Morgan, Lewis & Bockius LLP (Feb 7, 2005) (``Morgan, Lewis 
Letter'')). Our views about the issues raised by these commenters 
are set out throughout this Release.
---------------------------------------------------------------------------

1. Historical Context
    Until after World War I, broker-dealers provided investment advice 
exclusively as a part of the brokerage services for which customers 
paid fixed commissions (``traditional brokerage services'') \37\--in 
other words, customers did not pay a separate fee for that advice.\38\ 
Beginning in approximately 1920, however, some broker-dealers began 
offering investment advice for a separate and specific fee, typically 
through ``special departments'' within their firms.\39\ By 1940, when 
the Advisers Act was enacted, broker-dealers were providing investment 
advice in two distinct ways--as an auxiliary part of the traditional 
brokerage services for which their brokerage customers paid fixed 
commissions and, alternatively, as a distinct advisory service for 
which their advisory clients separately contracted and paid a fee.\40\
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    \37\ Then, as now, brokerage services included services provided 
throughout the execution of a securities transaction, including 
providing research and advice prior to a decision to buy or sell, 
implementing that decision on the most advantageous terms and 
executing the transaction, arranging for delivery of securities by 
the seller and payment by the buyer, maintaining custody of customer 
funds and securities, and providing recordkeeping services. See 
Exchange Act section 28(e)(3), 15 U.S.C. 78bb(e)(3). See also 
generally Charles F. Hodges, Wall Street (1930) (``Wall Street'').
    \38\ Sec, Report on Investment Counsel, Investment Management, 
Investment Supervisory, and Investment Advisory Services (1939) 
(H.R. Doc. No. 477) (``Investment Counsel Report'') at 3. Such 
investment advice provided by broker-dealers was ``an additional 
incentive to a purchaser or trader in securities to patronize 
particular brokers or investment bankers with the resultant increase 
in their brokerage or securities business.'' Id. at 4; see 
Inspection Report on the Soft-Dollar Practices of Broker-Dealers, 
Investment Advisers and Mutual Funds (prepared by the Commission's 
Office of Compliance Inspections and Examinations) (Sept. 22, 1998) 
(available on the Internet at http://www.sec.gov/news/studies/softdolr.htm) (``Since the early days of the brokerage industry, 
full-service broker-dealers have provided research and other 
services to customers in addition to executing trades as part of an 
overall package of services provided to customers. Customers have 
always paid for this in-house (or proprietary) research, as well as 
the other services, with commissions; normally no separate price tag 
was attached to such research or other services. Customers' 
commissions are used to pay, not only for execution services, but 
also for proprietary research, access to information and analysts' 
opinions on an as-needed basis, the brokerage firm's commitment to 
work difficult trades, and for the firm's willingness to commit 
capital and other resources for the customer's benefit. These 
practices continue today. The costs of these services are not 
separately itemized or billed to customers of brokerage firms but 
instead are considered part of the overall service provided to 
customers.'').
    \39\ See Twentieth Century Fund, The Security Markets (1935) at 
646-47 (``Security Markets''). Additionally, some broker-dealers 
created subsidiary companies to offer advisory services for a fee, 
or established affiliations with independent investment advisory 
firms to which they directed brokerage customers for paid advisory 
services. See id. at 647; see also Brokers to Bare Advisory 
Services, N.Y. Times, Oct. 19, 1934, at 33; Investment Counsel 
Report, supra note 38, at 4-5, 19-20.
    \40\ See, e.g., Investment Trusts and Investment Companies: 
Hearings on S. 3580 Before a Subcomm. of the Senate Committee on 
Banking and Currency, 76th Cong., 3d Sess. 736 (1940) (``Hearings on 
S. 3580'') (testimony of Dwight C. Rose, president of the Investment 
Counsel Association of America) (``Most * * * investment dealers * * 
* and brokers advise on investment problems, either as an auxiliary 
service without charge, or for specific charges allocated to this 
specific function.'').
---------------------------------------------------------------------------

    The advice that broker-dealers provided as an auxiliary component 
of traditional brokerage services was referred to as ``brokerage house 
advice'' in a leading study of the time.\41\ ``Brokerage house advice'' 
was extensive and varied,\42\ and included information about various 
corporations, municipalities, and governments; \43\ broad analyses of 
general business and financial conditions; \44\ market letters and 
special analyses of companies' situations; \45\ information about 
income tax schedules and tax consequences; \46\ and ``chart reading.'' 
\47\ The principal sources of auxiliary advice were firm 
representatives--known as ``customers' men'' until 1939 \48\--who 
served as the main point of contact with brokerage customers,\49\ and 
the ``statistical departments'' within firms, which provided research 
and analysis to customers' men or directly to the firms' brokerage 
customers.\50\
---------------------------------------------------------------------------

    \41\ See Security Markets, supra note 39, at 633-46 (discussing 
``brokerage house advice''). See also Wall Street, supra note 37, at 
253-85; Investment Counsel Report, supra note 38, at 1 n.1.
    \42\ E.g., Report of Public Examining Bd. on Customer Protection 
to N.Y. Stock Exchange, at 3 (Aug. 31, 1939): The customer entrusts 
the broker with information regarding his financial affairs and 
dealings which he expects to be kept in strict confidence. 
Frequently he looks to the broker to perform a whole series of 
functions relating to the investment of his funds and the care of 
his securities. Although he could secure similar services at his 
bank, he asks his broker, as a matter of choice and convenience, to 
hold credit balances of cash pending instructions; to retain 
securities in safekeeping and to collect dividends and interest; to 
advise him respecting investments; and to lend him money on suitable 
collateral.
    \43\ Security Markets, supra note 39, at 633; Wall Street, supra 
note 37, at 254 (``This information includes current and comparative 
data for a number of years on earning and earnings records, 
capitalization, financial position, dividend record, comparative 
balance sheets and income statements . . . production and operating 
statistics, territory and markets served, officers and directors of 
the company and much other information of value to the investor in 
appraising the value of a security'').
    \44\ Security Markets, supra note 39, at 634; Wall Street, supra 
note 37, at 254.
    \45\ Security Markets, supra note 39, at 640-43; Wall Street, 
supra note 37, at 277-85.
    \46\ Security Markets, supra note 39, at 641.
    \47\ Id. at 643 (defining ``chart reading'' as ``the study of 
the charted course of prices and volume of trading over a long 
period of time in order to discover typical conformations recurring 
in the past with sufficient frequency to be utilized in the present 
as a basis of judgment as to impending price changes'').
    \48\ Customers' Men Undecided on New Name; They Will Be Called 
Registered Representatives By Stock Exchange, Along With Other 
Groups, Wall St. J., May 13, 1939 at 7. See also SEC, Report on the 
Feasibility and Advisability of the Complete Segregation of the 
Functions of Dealer and Broker (June 20, 1936) (submitted to 
Congress by the Commission pursuant to section 11(e) of the Exchange 
Act) (``Segregation Study'') at 3; United States v. Brown, 79 F.2d 
321, 323 (2d Cir. 1935) (``Brokers have managers, clerks and so on 
who deal directly with their customers and on their advice the 
customers rely in investing'').
    \49\ Oliver J. Gingold, Give the Poor Customers' Man His Due, 
Barron's, May 24, 1937 at 11; The Broker Changes with the Changing 
Times, N.Y. Times Magazine, May 30, 1937 at 22 (``[T]he brunt of the 
demand for market advice falls on the boardroom philosopher and 
economist, otherwise known as the customers' man'').
    \50\ Security Markets, supra note 39, at 640; Wall Street, supra 
note 37, at 253. In the years following the stock market crash in 
1929, customers' men were made subject to a series of rules designed 
to ensure that they had the knowledge and experience required to 
advise customers and that they acted in the best interests of the 
customer. See Security Markets, supra note 39, at 638-40 (discussing 
and quoting rules adopted on May 7, 1930 by the Committee on 
Quotations of the New York Stock Exchange and on June 28, 1933 by 
the Exchange's Governing Committee); Wall St. Problem in Customers' 
Men, N.Y. Times, Jan. 14, 1934 at N7 (``[T]he Stock Exchange has 
approved rules prohibiting customers' men from handling 
discretionary accounts, which powers are now delegated with few 
exceptions, only to partners in Stock Exchange firms. * * * These 
employees, who were regarded merely as business getters in 1929, 
should be well-informed on financial matters and able to give sound 
investment advice to customers, brokers now believe.'').

---------------------------------------------------------------------------

[[Page 20429]]

    The second way in which broker-dealers dispensed advice was to 
charge a distinct fee for advisory services, which typically were 
provided through special ``investment advisory departments'' within 
broker-dealer firms that advised customers for a fee in the same manner 
as did firms whose sole business was providing ``investment counsel'' 
services.\51\ Through these special departments, broker-dealers offered 
two types of advisory accounts, one known as ``purely advisory'' and 
the other as ``discretionary.'' \52\ In purely advisory accounts, the 
``investment counsel undert[ook] to advise the client at stated 
intervals, or to keep him constantly advised, as to what changes ought, 
in the opinion of counsel, to be made in his holdings'' but left the 
ultimate decision about such changes to the client.\53\ Discretionary 
advisory accounts, on the other hand, provided the broker-dealer--
through powers of attorney or otherwise--additional ``control over the 
client's funds, with the power to make the ultimate determination with 
respect to the sale and purchase of securities for the client's 
portfolio.'' \54\ Broker-dealers generally charged for the advisory 
services provided to these accounts under the same system that had been 
adopted by the independent investment counseling firms--a fee based on 
a percentage of the market value of the cash and securities in the 
account being supervised.\55\ Securities transactions for the 
discretionary accounts were effected through the broker-dealer, and 
clients paid a commission on each trade.
---------------------------------------------------------------------------

    \51\ See Advisers Act Release No. 2, supra note 5. See also 
Security Markets, supra note 39, at 646, 653 (referring to 
``investment supervisory departments'' and ``special investment 
management departments'' of broker-dealers). In general, 
contemporaneous literature used the term ``investment counsel'' or 
``investment counselor'' to refer to those who provided investment 
advice for a fee and whose advisory relationship with clients had a 
supervisory or managerial character. See id. at 646 (defining 
``investment counselor'' as ``an individual, institution, 
organization, or department of an institution or organization which 
undertakes for a fee to advise or to supervise the investment of 
funds by, and on occasion to manage the investment accounts of, 
clients''). Under the Investment Advisers Act, ``investment 
counsel'' is a defined subset of the ``investment advisers'' to whom 
the Act applies. See section 208(c) of the Act.
    \52\ Security Markets, supra note 39, at 649-50. See also 
Investment Counsel Report, supra note 38, at 13-14.
    \53\ Security Markets, supra note 39, at 649. See also 
Investment Counsel Report, supra note 38, at 13.
    \54\ Investment Counsel Report, supra note 38, at 13; Security 
Markets, supra note 39, at 649 (noting that ``[g]enerally speaking, 
the larger independent investment counsel firms [were] more willing 
to take discretionary accounts than [were] the trust companies, the 
investment banks and those brokerage houses which undertake to 
perform the functions of investment counsel'').
    \55\ For example, one brokerage firm that had added an 
``extensive counsel service'' to its brokerage business in 1931 put 
that service on a ``fee basis'' in 1933 and charged an annual 
advisory fee of 0.25 percent of the market value of the account 
being supervised on accounts with a value of less than $1 million 
(with a minimum fee of $250) and a fee of 0.1 percent on accounts in 
excess of $1 million. Security Markets, supra note 39, at 653. See 
also Investment Counsel Report, supra note 38, at 16-17.
---------------------------------------------------------------------------

    Between 1935 and 1939, the Commission conducted a congressionally 
mandated study of investment trusts and investment companies and in 
connection with this study surveyed investment advisers.\56\ For those 
entities that did not engage solely in the business of providing 
investment advice for a fee, the ``study dealt only with the department 
of the organization engaged in the business of furnishing such 
service,'' \57\ including broker-dealers with investment advisory 
departments.\58\ Following the survey, the Commission held a public 
hearing at which representatives of the investment counsel industry 
offered testimony about the history of the investment counsel business, 
the nature of the services investment counsel provided, and what they 
saw as the main problems involved in the business of providing 
investment advice.\59\
---------------------------------------------------------------------------

    \56\ Investment Counsel Report, supra note 38, at 1. The study 
was conducted pursuant to section 30 of the Public Utility Holding 
Company Act of 1935 [15 U.S.C. 79z-4].
    \57\ Investment Counsel Report, supra note 38, at 1.
    \58\ See Hearings on S. 3580, supra note 40, at 995-96.
    \59\ Excerpts from that testimony are included in the Investment 
Counsel Report, supra note 38. A complete transcript of the 
Commission's February 11, 1938 hearing is reproduced in the 1938 
Investment Counsel Annual, At pages 97-154.
---------------------------------------------------------------------------

    In a report to Congress (the ``Investment Counsel Report''), the 
Commission informed Congress that the Commission's study had identified 
two broad classes of problems relating to investment advisers that 
warranted legislation: ``(a) the problem of distinguishing between bona 
fide investment counselors and `tipster' organizations; and (b) those 
problems involving the organization and operation of investment counsel 
institutions.'' \60\ Based on the findings of the Investment Counsel 
Report, representatives of the Commission testified at the 
Congressional hearings on what ultimately became the Advisers Act in 
favor of regulating the largely unregulated community of persons 
engaged in the business of providing investment advice for 
compensation. As Commission staff explained, a ``compulsory census'' in 
the form of a registration requirement for investment advisers was 
necessary both to protect investors against the unregulated ``fringe'' 
offering investment advisory services and to advance the interests of 
legitimate investment counselors by eliminating ``tipsters'' who 
``crash in on the good will of these reputable organizations * * * by 
giving themselves a designation of investment counselors.'' \61\
---------------------------------------------------------------------------

    \60\ Investment Counsel Report, supra note 38, at 27.
    \61\ Hearings on S. 3580, supra note 40, at 50-51. See also S. 
Rep. No. 76-1775, supra note 10, at 21-22; H.R. Rep. No. 76-2639, 
76th Cong., 3d Sess. 28 (1940) (``H.R. Rep. No. 76-2639'') at 28.
---------------------------------------------------------------------------

    Congress chose to fill this regulatory gap by passing the Advisers 
Act. Section 202(a)(11) of the Act defined ``investment adviser''--
those subject to the requirements of the Act--broadly to include ``any 
person who, for compensation, engages in the business of advising 
others, either directly or through publications or writings, as to the 
value of securities or as to the advisability of investing in, 
purchasing, or selling securities, or who, for compensation and as part 
of a regular business, issues or promulgates analyses or reports 
concerning securities * * *'' In adopting this broad definition, 
Congress necessarily rejected arguments presented during its hearings 
that legitimate investment counselors should be free from any oversight 
except, perhaps, by the few states that had passed laws regulating 
investment counselors \62\ and by private

[[Page 20430]]

organizations, such as the Investment Counsel Association of 
America.\63\ Instead, in responding to such views, congressional 
committee members repeatedly observed that those whose business was 
limited to providing investment advice for compensation were subject to 
little if any regulatory oversight, and questioned why they should not 
be subject to regulation even though other professionals were.\64\
---------------------------------------------------------------------------

    \62\ Hearings on S. 3580, supra note 40, at 745-748. Two 
commenters suggested that this testimony by investment counselors, 
which included references to differences between independent 
investment counselors and broker-dealers who provided investment 
advice, supports the notion that Congress intended the Act to 
broadly cover broker-dealer investment advice. See CFA Letter, supra 
note 28; FPA Letter, supra, note 27. In support of this, one 
commenter points to the statement of Dwight Rose that ``[s]ome of 
these organizations using the descriptive title of investment 
counsel were in reality dealers or brokers offering to give advice 
free in anticipation of sales and brokerage commissions on 
transactions executed upon such free advice'' as evidence that 
Congress was concerned about bringing such broker-dealers under the 
scope of the Act. CFA Letter, supra note 28 (citing Hearings on S. 
3580, supra note 40, at 736). Mr. Rose's comments, however, were 
part of his identification of the various sorts of persons who 
rendered advice--not a call for regulation of those persons. 
Instead, consistent with the bulk of the hearings, the comments were 
offered in the context of an extended discussion of why investment 
counselors believed that the proposed legislation was unnecessary in 
its entirety. Moreover, the members of the committees holding 
hearings on the proposed legislation were also informed by 
investment counselors who testified on the legislation, that it 
would cover only broker-dealers who were separately paid for the 
giving of investment advice (see Hearings on S. 3580, supra note 40, 
at 711; Investment Trusts and Investment Companies: Hearings on H.R. 
10065 Before a Subcomm. of the House Committee on Interstate and 
Foreign Commerce, 76th Cong., 3d Sess. at 87 (1940) (``Hearings on 
H.R. 10065''))--which would not include the broker-dealers to which 
Mr. Rose was referring.
    \63\ Hearings on S. 3580, supra note 40, at 716-18, 736-38, 740-
41, 744-45, 760, 763.
    \64\ Hearings on S. 3580, supra note 40, at 738-39, 745-49, 751-
53 (Senators Wagner and Hughes). David Schenker, chief counsel for 
the Commission's study, offered the following observations in 
response to investment counselors' arguments against the 
registration and regulation required by the Act:
    ``Then there is another curious thing, Senator, that those 
people who are subject to supervision by some authoritative body of 
some kind, such as securities dealers or investment bankers have to 
register with us as brokers and dealers. People, who are brokers and 
members of stock exchanges and are supervised by the stock 
exchanges. Curiously enough, the people in the investment-counsel 
business who are supervised are not eligible for membership in the 
investment counsel association; because the association says that if 
you are in the brokerage or banking business you cannot be a member 
of the association.
    ``So the situation is that if you take their analysis, the only 
ones who would not be subject to regulation by the S.E.C. would be 
the people who are not subject to regulation by anybody at all. 
These investment counselors who appeared here are no different from 
the over-the-counter brokers and dealers or the members of the New 
York Stock Exchange. All we ask them to do is file a registration 
statement which asks ``What is your name and address, and have you 
ever been convicted of a crime?''
    Hearings on S. 3580, supra note 40, at 995-96. Eventually, 
members of the investment counsel industry agreed with the proposed 
legislation. See id. at 1124; Hearings on H.R. 10065, supra note 62. 
See also S. Rep. No. 76-1775, supra note 10, at 21; H.R. Rep. No. 
76-2639, supra note 61, at 27.
---------------------------------------------------------------------------

    Conversely, in recognition of the fact that the broad definition of 
``investment adviser'' also captured a number of individuals and 
entities that were already subject to substantial oversight and 
regulation,\65\ the Act specifically excepted such persons, among 
others, to the extent they rendered investment advice as part of their 
other regular business.\66\ Broker-dealers were among these already-
regulated persons, and section 202(a)(11)(C) of the Act excepts from 
the definition of ``investment adviser'' a broker-dealer who provides 
investment advice that is ``solely incidental to the conduct of his 
business as a broker or dealer and who receives no special compensation 
therefor.''
---------------------------------------------------------------------------

    \65\ Members of the congressional committees conducting the 
hearings on the Advisers Act suggested that the broad definition 
could result in overlapping (and unnecessary) regulation--
particularly of lawyers providing investment advice. See, e.g., 
Hearings on H.R. 10065, supra note 62, at 88 (statement of 
Congressman Cole) (``[I]n the hearings in the Senate, several of the 
Senators raised considerable objection to the possibility of the 
bill reaching law firms * * * and I gather from reading the 
testimony and discussions on the bill, that the only reason these 
law firms are not under the bill is that they are pretty well 
regulated at home.''). One commenter argued that we ``created a 
distorted picture'' of the historical record, however, by failing to 
cite to congressional testimony of a Commission employee that it was 
appropriate to except lawyers from the proposed legislation because, 
in addition to being regulated by state bar associations, lawyers 
are subject to a ``high fiduciary duty'' to their clients. See CFA 
Letter, supra note 28 (citing Hearings on S. 3580, supra note 40, at 
49). From this, the commenter implies that Congress would have 
considered a ``high fiduciary duty'' to be a prerequisite for an 
exception from the definition of ``investment adviser.'' We cannot 
agree, however, because the same provision excepting lawyers also 
excepts other professionals (engineers and teachers) who have never 
been regarded as traditional fiduciaries.
    \66\ This exception for certain professionals is very similar to 
certain state-law provisions governing investment counselors at the 
time, which excepted ``brokers, attorneys, banks, savings and loan 
associations, trust companies, and certified public accountants.'' 
See Statutory Regulation of Investment Advisers (prepared by the 
Research Department of the Illinois Legislative Council) (``Illinois 
Legislative Council Report'') reprinted in Hearings on S. 3580, 
supra note 40, at 1007. That report stated that ``the basic reason 
[for such exceptions] seems to be that such persons and firms are 
already subject to governmental regulation of one type or another 
[and] * * * the investment advice furnished by these excepted groups 
would seem to be merely incidental to some other function being 
performed by them.'' Id.
---------------------------------------------------------------------------

2. Our Conclusions
    We draw two relevant conclusions from this legislative history as 
well as from the brokerage customs of 1940. First, as drafted in 1940, 
the Advisers Act avoided additional and largely duplicative regulation 
of broker-dealers, which were regulated under provisions of the 
Exchange Act that had been enacted six years earlier.\67\ Second, the 
broker-dealer exception in the Advisers Act was understood to 
distinguish between broker-dealers who provided advice to customers 
only as part of the package of traditional brokerage services for which 
customers paid fixed commissions--who were not covered by the Advisers 
Act \68\--and broker-dealers who also provided advisory services 
(typically through their special advisory departments) for which 
customers separately contracted and paid a fee--who were covered by the 
Act.\69\ As the legislative history shows, representatives of the 
investment counsel industry who participated in the Advisers Act 
hearings (and cooperated in drafting the version of the

[[Page 20431]]

bill that Congress ultimately enacted) \70\ understood that broker-
dealers offered investment advice both as part of their traditional 
commission brokerage services and, alternatively, for a separate fee 
through special departments,\71\ and that the Advisers Act was intended 
to reach only the latter.\72\ The earliest Commission staff 
interpretations of the Advisers Act also reflect the same 
understanding, i.e., that the Act was intended to cover broker-dealers 
only to the extent that they were offering investment advice as a 
distinct service for which they were specifically compensated (which it 
was ``well known'' they were doing through special advisory 
departments).\73\
---------------------------------------------------------------------------

    \67\ Pub. L. 73-291, 48 Stat. 881 (June 6, 1934). Four years 
later in the Maloney Act, Congress amended the Exchange Act to 
authorize the Commission to register national securities 
associations. Pub. L. No. 75-719, 52 Stat. 1070 (June 25, 1938). One 
commenter suggested that, in determining that the broker-dealer 
exception (and the other exceptions) reflected a decision to avoid 
additional and largely duplicative regulation, we disregarded 
evidence that the exception was included for other reasons that 
support a narrower construction of the exception. See CFA Letter, 
supra note 28. In fact, we have not stated that the only purpose of 
section 202(a)(11)(C) was to avoid duplicative regulation. We have 
also focused on strong evidence that the exception reflected an 
intent to remove from the coverage of the Act only certain broker-
dealers: those who provided investment advice as part of the package 
of brokerage services for which customers were paying commissions, 
as opposed to those broker-dealers who were providing advice for a 
fee, typically through separate advisory departments.
    \68\ See S. Rep. No. 76-1775, supra note 10, at 22; H.R. Rep. 
No. 76-2639, supra note 61, at 28. See also Thomas P. Lemke & Gerald 
T. Lins, Regulation of Investment Advisers Sec.  1:19 (``The 
exception in section 202(a)(11)(C) was included in the Advisers Act 
because broker-dealers routinely give investment advice as part of 
their brokerage activities, yet are already subject to extensive 
regulation under the 1934 Act and possibly state law''); Thomas P. 
Lemke, Investment Advisers Act Issues for Broker-Dealers, Securities 
& Commodities Regulation at 214 (Dec. 9, 1987) (``While most broker-
dealers initially will come within the definition of an investment 
adviser, it is clear that Congress did not intend brokerage 
activities to be regulated under the 1940 Act [citing S. Rep. No. 
76-1775]. Rather, such activities were intended to be regulated 
under the 1934 Act without the additional and often duplicative 
requirements under the 1940 Act.'').
    \69\ One commenter disputed our conclusion that the Act was 
drafted to cover the sort of advice that, in 1940, was provided 
through the separate advisory departments of broker-dealers. CFA 
Letter, supra note 28. In support of its contrary contention that 
Congress intended the Act to apply to most of the advice provided by 
broker-dealers in 1940--including advice provided as part of the 
package of brokerage services for which broker-dealers received only 
commissions--this commenter pointed to an excerpt from the Illinois 
Legislative Council Report that describes the risk that investment 
counselors associated with brokerage houses would ``unduly urge 
frequent buying and selling of securities, even when the wisest 
procedure might be for the client to retain existing investments.'' 
CFA Letter, supra note 28 (quoting Illinois Legislative Council 
Report, supra note 66, at 1014). This excerpt, however, is 
consistent with our reading of the broker-dealer exception. In 
describing the sort of ``association'' with brokerage houses that 
would give rise to the risk described above, the report stated that 
``[m]any counselors have some connection, direct or indirect, with 
[broker-dealer] * * * firms, although such connections are not 
universal. Furthermore, brokers and dealers in securities frequently 
maintain an investment counsel service in connection with their 
other activities.'' Illinois Legislative Council Report, supra note 
66, at 1014). This excerpt indicates that, to the extent that 
broker-dealers were the investment counselors who gave rise to the 
concern, they were offering advisory services through special 
investment advisory departments--precisely the sort of advisory 
services we have concluded the Act was drafted to reach.
    \70\ See Hearings on S. 3580, supra note 40, at 1124.
    \71\ Id. at 736.
    \72\ Id. at 711 (testimony of Douglas T. Johnston, vice-
president of Investment Counsel Association of America) (``The 
definition of `investment adviser' as given in the bill * * * would 
include * * * certain investment banking and brokerage houses which 
maintain investment advisory departments and make charges for 
services rendered * * *.''.). One commenter asserted that because 
this testimony was offered at a time when the draft legislation 
contained no explicit exception for broker-dealers, it cannot be 
taken as evidence of the type of advisory services by broker-dealers 
that the legislation was intended to cover. See CFA Letter, supra 
note 28, at 7. Instead, the commenter contended, the final 
legislation--which contains an express exception for broker-
dealers--reaches a broader range of broker-dealer investment advice 
than Mr. Johnston's testimony suggested. We believe that the later 
addition of the exception for broker-dealers cannot reasonably be 
read to have expanded the group of broker-dealers to which the Act 
would apply. In our view, the better reading of the record is that 
Mr. Johnston--who participated in the Commission hearings that gave 
rise to the proposed legislation (see Investment Counsel Report, 
supra note 38, at 2, n.7)--understood that the legislation was never 
intended to reach the sort of investment advice provided by broker-
dealers as part of the package of brokerage services for which 
customers paid commissions. See Investment Counsel Report, supra 
note 38, at 1, n.1 (the Commission study ``included only those 
persons or organizations who were engaged primarily in the business 
of furnishing investment counsel or advice and therefore did not 
include lawyers, accountants, trustees, customers' men in brokerage 
offices, security brokers and dealers, and other similar persons who 
may give investment advice in similar capacities'').
    \73\ See Advisers Act Release No. 2, supra note 5 (``[T]hat 
portion of clause (C) which refers to `special compensation' amounts 
to an equally clear recognition that a broker or dealer who is 
specially compensated for the rendition of advice should be 
considered an investment adviser and not be excluded from the 
purview of the Act merely because he is also engaged in effecting 
market transactions in securities. It is well known that many 
brokers and dealers have investment advisory departments which 
furnish investment advice for compensation in the same manner as 
does an investment adviser who operates solely in an advisory 
capacity.''). One commenter argued that the foregoing reference to 
``investment advisory departments'' does not support our conclusion 
that the Act was drafted to cover the sort of advisory services 
provided by such departments, but ``simply supports the document's 
preceding assertion, that a broker is not `excluded from the purview 
of the Act merely because he is also engaged in effecting market 
transactions in securities.' '' See CFA Letter, supra note 28. We 
cannot agree. The point of the reference is to identify the type of 
advisory services provided by broker-dealers for compensation that 
the Act was intended to reach.
---------------------------------------------------------------------------

    Although, as discussed above, the Advisers Act was written in such 
a way that it covers fee-based programs because the fee would 
constitute ``special compensation,'' we do not believe that it would be 
consistent with Congress' intent to apply the Act to cover broker-
dealers providing advice as part of the package of brokerage services 
they provide under fee-based brokerage programs. First, as we have 
said, one of the reasons Congress enacted the broker-dealer exception 
was to avoid largely duplicative regulation. If anything, broker-
dealers today are subject to a level of regulation far greater than in 
1940, as we explain below. Much of that regulation concerns matters 
pertinent to their advice-giving function.
    Second, the Advisers Act was enacted in an era when broker-dealers 
were paid fixed commission rates \74\ for the traditional package of 
services (including investment advice) excepted from the Act, and, 
therefore, Congress understood ``special compensation'' to mean non-
commission compensation.\75\ There is no evidence that the ``special 
compensation'' requirement was included in section 202(a)(11)(C) for 
any purpose beyond providing an easy way of accomplishing the 
underlying goal of excepting only advice that was provided as part of 
the package of traditional brokerage services.\76\ In particular, 
neither the legislative history of section 202(a)(11)(C) nor the 
broader legislative history of the Advisers Act as a whole suggests 
that, in 1940, Congress viewed the form of compensation for the 
services at issue--commission versus fee-based compensation--as having 
any independent relevance in terms of the advisory services the Act was 
intended to reach.
---------------------------------------------------------------------------

    \74\ The practice of fixing commission rates on stock exchanges 
in the United States is generally traced back to the so-called 
Buttonwood Tree Agreement of 1792, which provided: ``We, the 
Subscribers, Brokers for the Purchase and Sale of Public Stock, do 
hereby solemnly promise and pledge ourselves to each other, that we 
will not buy or sell from this day forward for any person 
whatsoever, any kind of Public Stock at a less rate than one-quarter 
percent Commission on the Specie value of, and that we will give a 
preference to each other in our Negotiations. In Testimony whereof 
we have set our hands this 17th day of May, at New York, 1792.'' 
Eames, The New York Stock Exchange 14 (1894).
    In 1975, the Commission adopted rule 19b-3 [17 CFR 19b-3] which 
eliminated the fixed commission rate structure on national 
securities exchanges. See generally Exchange Act Release No. 11203 
(Jan. 23, 1975) [40 FR 7394 (Feb. 20, 1975)].
    \75\ At the time the Advisers Act was enacted, Congress 
understood ``special compensation'' to mean compensation other than 
commissions. S. Rep. No. 76-1775, supra note 10, at 22 (``The term 
`investment adviser' is so defined as specifically to exclude * * * 
brokers (insofar as their advice is merely incidental to brokerage 
transactions for which they receive only brokerage commissions.)'') 
(emphasis added). See also H. Rep. No. 2639, supra note 61.
    \76\ Of course, the absence of ``special compensation'' was 
necessary but not sufficient for the section 202(a)(11)(C) 
exception. The other requirement--that the advice be provided 
``solely incidental to'' the conduct of the brokerage business--has 
always required a judgment based on the facts and circumstances and 
was not the sort of ``bright-line'' test that non-commission 
``special compensation'' was.
---------------------------------------------------------------------------

    To the extent fee-based brokerage programs offer a package of the 
same types of services that Congress intended the Advisers Act not to 
cover,\77\ the rule we are adopting today is necessary to prevent the 
Act from reaching beyond Congress' intent.\78\ Today, fee-based 
brokerage programs are offered by most of the larger broker-dealers, 
and hold over $268 billion of customer assets.\79\ Although this is 
still a relatively small number, it is estimated that assets in fee-
based brokerage programs nationwide grew by 60.9 percent during 2003-
2004.\80\ 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.\81\ 
Our failure to adopt this rule could eventually result in the extension 
of the Advisers Act to many brokerage relationships. Such a result 
would be inconsistent with the

[[Page 20432]]

intent of the Advisers Act, which, as discussed earlier, was designed 
to fill a regulatory gap that had permitted firms and individuals to 
engage in advisory activities without being regulated.\82\ Moreover, 
such a result would create substantial regulatory overlap, which the 
Act was drafted to avoid.\83\ Far from being a radical departure from 
existing regulatory policy as suggested by some commenters, we believe 
the primary effect of rule 202(a)(11)-1 will be to maintain the 
historical ability of full-service broker-dealers to provide a wide 
variety of services, including advisory services, to brokerage 
customers, without requiring those broker-dealers to treat those 
clients as advisory clients.
---------------------------------------------------------------------------

    \77\ When brokers re-price traditional commission-based 
brokerage accounts, they create a different set of incentives for 
their registered representatives. Thus, it is not surprising to us, 
nor is it inconsistent with the design of the rule we are today 
adopting, that customers with fee-based brokerage accounts may 
obtain a different level or quality of services, including advisory 
services, than do customers with commission-based brokerage 
accounts. Indeed, one of the aims of the Tully Commission, as 
articulated in its report, was to create incentives for brokers to 
improve the quality of the services provided their customers. See 
Tully Report, supra note 12.
    \78\ In reaching this conclusion, we are exercising our 
authority under section 202(a)(11)(F) to except ``such other persons 
not within the intent of'' the definition of ``investment adviser'' 
in section 202(a)(11). Broker-dealers who provide investment advice 
solely incidental to traditional brokerage services for a fee are a 
group which, as discussed above, could not have existed at the time 
Congress enacted the Advisers Act because, in 1940, broker-dealers 
were paid only fixed commissions for traditional brokerage services. 
Such broker-dealers are therefore ``other persons'' within the 
meaning of section 202(a)(11)(F).
    \79\ The Cerulli Edge, Managed Accounts Edition (1st Quarter 
2005) (``Cerulli Edge 1st Quarter 2005''). One commenter asserted 
that fee-based accounts represent 6.4% of the $3.9 trillion of 
securities currently held by individual investors. FPA Letter, supra 
note 27.
    \80\ Cerulli Edge 1st Quarter 2005, supra note 79.
    \81\ The Cerulli Edge, Managed Accounts Edition (1st Quarter 
2004).
    \82\ See supra notes 56-64 and accompanying text.
    \83\ See supra notes 65-66 and accompanying text. One commenter 
contended that in reaching this conclusion about the purpose of the 
broker-dealer exception, we did not adequately account for a 
discussion in the Illinois Legislative Council Report addressing 
different ways the State of Illinois might exempt certain 
professionals from regulation as investment counselors. See CFA 
Letter, supra note 28. The Illinois report stated that ``[a]part 
from deciding the merits of each claim for exemption, a decision 
would have to be made as to whether to exempt only those who 
incidentally and occasionally give advice as to investments or 
whether to exempt as a general rule all who regularly furnish 
investment advice if they also belong to one of the groups in 
relation to which some other form of government regulation exists.'' 
Illinois Legislative Council Report, supra note 66, at 1007-1008 
(emphasis supplied). According to the commenter, this excerpt 
indicates that, because Congress did not provide a ``blanket 
exception'' for broker-dealers, (1) Congress necessarily chose to 
except only broker-dealers who `` `incidentally and occasionally 
give advice on investments' ''; and (2) the exception cannot have 
been based on any concern about overlapping or duplicative 
regulation. CFA Letter, supra note 28. We cannot agree. Most 
critically, the broker-dealer exception in the Advisers Act says 
nothing about advisory services being only ``occasional.'' Thus, to 
the extent the formulation in the state report is relevant here, it 
tends to indicate that the drafters of the Advisers Act chose not to 
limit the broker-dealer advice excepted by section 202(a)(11)(C) to 
advice that is provided only occasionally. Further, even accepting 
the commenter's reading of the state report, there is no basis for 
concluding that Congress' concern about duplicative or overlapping 
regulation could have been addressed only by a blanket exception 
from the Act. The more reasonable view is that the drafters of the 
qualified exception in section 202(a)(11)(C) took account of the 
recent and substantial regulation of broker-dealers (see supra note 
67) and balanced the interest in avoiding multiple regulation of 
broker-dealers against the interest in regulating as advisers, 
broker-dealers who were providing investment advisory services 
through ``investment advisory departments * * * for compensation in 
the same manner as does an investment adviser who operates solely in 
an advisory capacity.'' Investment Advisers Act Release No. 2, supra 
note 5. Indeed, although there are clear statements in the 
historical record that the exception for lawyers in section 
202(a)(11)(B) was based in large part on a desire to avoid multiple 
regulation (Hearings on H.R. 10065, supra note 62, at 88) the Act 
does not provide a blanket exception for lawyers, either.
---------------------------------------------------------------------------

    The arguments of many commenters opposed to the reproposed rule go 
to a fundamental set of issues they have with the statutory broker-
dealer exception in the Advisers Act. Notwithstanding the statutory 
exception, these commenters argue that broker-dealers providing any 
investment advice should be registered as investment advisers under the 
Advisers Act.\84\ They assert that today, brokerage is incidental to 
the advisory services provided by full-service broker-dealers,\85\ and 
point to brokerage advertising that emphasizes the quality of the 
advisory services provided by the broker-dealer as indicative of this 
change.\86\ These comments fail to give weight to Congress' decision to 
include the exception in the Advisers Act, and fail to recognize the 
historical role of advice in retail brokerage.
---------------------------------------------------------------------------

    \84\ See supra note 27.
    \85\ See, e.g., AICPA Letter, supra note 31; Joint Letter of 
Fund Democracy et al., supra note 28. See also FPA Jan. 14, 2000 
Letter, supra note 19.
    \86\ See, e.g., CFA Letter, supra note 28; CFP Board Letter, 
supra note 28; Joint Letter of Fund Democracy et al., supra note 28; 
T. Rowe Price Letter, supra note 28. See also CFA Jan. 13, 2000 
Letter, supra note 19; Joint Comment Letter of Consumer Federation 
of America, Fund Democracy, Investment Counsel Association of 
America, Financial Planning Association, Certified Financial Planner 
Board of Standards, Inc., and National Association of Personal 
Financial Advisors (May 6, 2003); Comment Letter of Strategic 
Compliance Concepts, Ltd. (Sept. 9, 2004); Dix Letter, supra note 
32; Comment Letter of Joseph Capital Management (Nov. 7, 2004).
---------------------------------------------------------------------------

    Broker-dealers have traditionally provided investment advice that 
is substantial in amount, variety, and importance to their 
customers.\87\ Full-service broker-dealers have always sought to 
develop long-term relationships with their customers who often come to 
rely on them for expert investment advice.\88\ And full-service retail 
broker-dealers have always relied on ancillary services, such as 
advisory services, to promote and sell their brokerage services.\89\ 
The nature, amount and significance of the advice broker-dealers 
provided as part of traditional brokerage services was evident in 1940 
when Congress expressly excepted broker-dealers from the Advisers Act 
to the extent they were providing advice in that context.\90\ A rule or 
interpretation of the Advisers Act that would apply the Act to broker-
dealers merely because their advice is important or valuable to 
customers, or who market themselves based on their advice, as 
commenters suggested, would extend the Act to most full-service broker-
dealers--a result at conflict with the purpose of the statutory 
exception.
---------------------------------------------------------------------------

    \87\ See supra notes 37-55 and accompanying text.
    \88\ See id.
    \89\ See, e.g., Investment Counsel Report, supra note 38, at 4 
(``The availability of such [advisory] service to investors created 
an additional incentive to a purchaser or trader in securities to 
patronize particular brokers or investment bankers with the 
resultant increase in their brokerage or securities business'').
    \90\ See supra notes 37-66 and accompanying text. In the 1930s, 
there were a significant number of individual security holders. 
Thus, for example, according to the Twentieth Century Fund's 1935 
discussion of the securities markets, in 1930 around 10 million 
individuals owned stock in American corporations and these ten 
million were about 20 per cent of the population ``over 10 years of 
age gainfully employed.'' Security Markets, supra note 39, at 54. In 
1940, the Temporary National Economic Committee estimated that in 
1937 there were from eight to nine million individual share owners--
about 1 in 15 inhabitants of the country and around 1 in 5 persons 
receiving income--who held stock in at least one corporation. 
Temporary National Economic Committee, The Distribution of Ownership 
in the 20 Largest Nonfinancial Corporations at 9. See also Brookings 
Institution, Share Ownership in the United States, App. A (1952) 
(discussing shareholdings in 45 common stocks listed on the New York 
Stock Exchange for the years 1930 to 1950 and noting that there was 
an extremely sharp rise in shareholdings from 1930 to 1935 followed 
by an ``apathetic market'' in the period 1935-1940).
---------------------------------------------------------------------------

    As a general matter, broker-dealers and investment advisers have, 
in the past, often provided similar advisory services and competed for 
similar clients seeking similar advice. Applying the Act to a broker-
dealer whenever it provides investment advice would seem to necessarily 
apply the Act to every full-service brokerage account once advice is 
provided. Whatever policy advantages one might conclude could be gained 
by such a result, we believe it would be inconsistent with the 
conclusions reached by Congress when it passed the Act.\91\
---------------------------------------------------------------------------

    \91\ For the same reason, we do not believe that the competitive 
concerns of many of the financial planners that commented on the 
proposal and reproposal counsel against adopting this rule.
---------------------------------------------------------------------------

    Many commenters opposing the proposed rule focused their arguments 
on additional investor protections that regulation under the Advisers 
Act provides and argued that the rule would harm investors.\92\ There 
are differences between the regulatory frameworks provided by the 
Exchange Act and the Advisers Act, but Congress was well aware of these 
differences when it passed the Advisers Act and excepted broker-dealers 
from the definition of investment adviser.\93\ Broker-dealers are

[[Page 20433]]

subject to oversight by the Commission as well as by one or more SROs 
under the Exchange Act. The Exchange Act, Commission rules, and those 
of the SROs provide substantial protections for broker-dealer 
customers.\94\ Given that broker-dealers are today subject to a level 
of regulation far greater than in 1940, we believe that the rule is 
consistent with the statute's intent to avoid largely duplicative 
regulation of firms already subject to Commission oversight.\95\
---------------------------------------------------------------------------

    \92\ AICPA Letter, supra note 31; CFP Board, supra note 28; FPA 
Letter, supra note 27; NAPFA Letter, supra note 31; AARP Letter, 
supra note 28. See also CFA Jan. 13, 2000 Letter, supra note 19; FPA 
Jan. 14, 2000 Letter, supra note 19; ICAA Jan. 12, 2000 Letter, 
supra note 19.
    \93\ Many commenters focused on the conflicts under which 
broker-dealers function, arguing that the rule is ``anti-consumer'' 
in that broker-dealers are not subject to the same obligations to 
disclose conflicts as are advisers. See, e.g., FPA Letter, supra 
note 27. As noted above, however, Congress was well aware of these 
conflicts when it passed the Advisers Act. See, e.g., Hearings on S. 
3580, supra note 40 at 736 (``Some of these organizations using the 
descriptive title of investment counsel were in reality dealers or 
brokers offering to give advice free in anticipation of sales and 
brokerage commissions on transactions executed upon such free 
advice''); Investment Counsel Report, supra note 38, at 23-25 
(quoting testimony of investment advisers regarding ``vital 
conflicts'' in broker-dealers providing investment advice when they 
were at the same time intending to sell particular securities they 
owned); Illinois Legislative Council Report, supra note 66, at 1010 
(``This might give rise to questions as to whether a counselor who 
is also a dealer or broker can be relied upon always to give 
unbiased advice.''); Segregation Study, supra note 48, at xv (``A 
broker who trades for his own account or is financially interested 
in the distribution or accumulation of securities, may furnish his 
customers with investment advice inspired less by any consideration 
of their needs than by the exigencies of his own position.''). 
Despite such conflicts, Congress nonetheless determined to except 
brokers providing such advice from the scope of the Advisers Act.
    One commenter challenged this conclusion, maintaining that the 
legislative history showed that ``the intermingling of brokerage and 
advising functions was a significant part of the problem Congress 
was attempting to resolve'' by passing the Advisers Act, implying 
that the Act was drafted to broadly cover investment advice provided 
by broker-dealers. FPA Letter, supra note 27. The testimony on which 
the commenter relies (see Hearings on S. 3580, supra note 40, at 
725), however, did not address advice supplied by brokers as a part 
of the package of brokerage services for which they charged only 
commissions, but concerned broker-dealers that had separate 
investment advisory departments that provided investment advice to 
clients for a fee, precisely the sort of advisory services that we 
have stated the Act was drafted to cover.
    Broker-dealers are subject to more obligations to disclose 
conflicts today than they were in 1940. Those obligations derive 
from many sources, including agency law, the shingle theory, 
antifraud provisions of the securities laws and the rules and 
regulations of the Commission and the SROs. Required disclosures in 
client communications include those relating to investment 
recommendations (e.g., the nature of any financial interest the 
broker-dealer and/or any of its officers or directors have in any 
securities of an issuer (NASD IM-2210-1)); confirmations (e.g., 
disclosure of principal or agency execution status and compensation 
to the broker (Exchange Act rule 10b-10)); marketing materials 
(e.g., must be fair and balanced and provide a sound basis for 
evaluating the facts (NASD Rule 2210(d)); customer statements (e.g., 
quarterly account statements must contain a description of any 
securities positions, money balances and account activity (NASD Rule 
2340(a)), and margin disclosure statements (e.g., must discuss 
operation and risks of trading on margin (NASD Rule 2341)). In 
addition, the Commission has proposed ``point of sale'' disclosure 
requirements and additional customer confirmation requirements for 
broker-dealers to provide cost and conflict of interest information 
to investors in mutual funds, unit investment trust interests and 
college savings plan interests. See Securities Act Release No. 8358 
(Jan. 29, 2004 [69 FR 6438 (Feb. 10, 2004)] and Securities Act 
Release No. 8544 (Feb. 28, 2005 [70 FR 10521 [Mar. 4, 2005]). 
Broker-dealers must also disclose information about revenue sharing 
arrangements for the sale of mutual funds. See In the Matter of 
Morgan Stanley DW Inc., Exchange Act Release No. 34-48789 (Nov. 17, 
2003); In the Matter of Edward D. Jones & Co., L.P., Exchange Act 
Release No. 34-50910 (Dec. 22, 2004); In the Matter of Putnam 
Investment Management, LLC, Advisers Act Release No. 2370 (Mar. 23, 
2005). See also In the Matter of Citigroup Global Markets, Inc., 
Exchange Act Release No. 34-51415 (Mar. 23, 2005) (in addition to 
revenue sharing arrangements, also required to disclose material 
information regarding overall rate of return for purchase of Class A 
shares rather than Class B shares).
    \94\ An entity that wishes to act as a broker-dealer, and that 
does not qualify for an exemption, must register both with the 
Commission and with at least one SRO. See Exchange Act section 
15(b)(8). The Uniform Application for Broker-Dealer Registration, 
Form BD, requires broker-dealers to disclose detailed information 
about their business, including their disciplinary history, if any. 
Similar information about registered personnel of broker-dealers 
must be disclosed on Form U4, the Uniform Application for Securities 
Industry Registration. This information is maintained in the Central 
Registration Depository (CRD), which is operated by the National 
Association of Securities Dealers, Inc. (NASD). Much of this 
information, including disciplinary history, is made publicly 
available by NASD through BrokerCheck. All registered personnel of 
broker-dealers must pass examinations administered by the NASD in 
order to work for a broker-dealer and complete continuing education 
requirements. Registered securities representatives must be 
supervised by a principal of the broker-dealer who is also 
registered with the NASD. See NASD Conduct Rule 3010(a)(5).
    Under the anti-fraud provisions in Sections 9(a), 10(b), and 
15(c)(1) and (2) of the Exchange Act and the regulations thereunder, 
as well as the rules of the various SROs, broker-dealers owe their 
customers a duty of fair dealing, have a duty of best execution and 
are required to make only suitable recommendations. They are also 
subject to various financial responsibility requirements, including 
segregation of customer assets and capital adequacy requirements, as 
well as recordkeeping and reporting requirements. See Exchange Act 
Rules 15c3-1, 15c3-3, 17a-3, 17a-4, 17a-5, and 17c-11. Moreover, 
broker-dealers are subject to statutory disqualification standards 
and the Commission's disciplinary authority, which are designed to 
prevent persons with any disciplinary history from becoming, or 
becoming associated with, registered broker-dealers. See Exchange 
Act sections 3(a)(39), 15(b)(4) and 15(b)(6). See also Reproposing 
Release, supra note 6, at n. 51-52 and accompanying text.
    \95\ For example, while our staff examinations of broker-dealers 
offering fee-based accounts suggest that some firms may be 
maintaining such accounts for customers in instances in which they 
are not appropriate--for example for a customer whose trading 
activity is limited--we note that the SROs are taking steps to 
address this practice. The NASD has issued a Notice to Members 
requiring supervisory procedures to determine whether fee-based 
brokerage is appropriate for a customer and periodic review of the 
customer's accounts to determine whether it continues to be 
appropriate. NASD Notice to Members No. 03-68 (Nov. 2003). The NYSE 
has filed a proposed rule with the Commission that would also deal 
with these issues. SR-NYSE-2004-13.
---------------------------------------------------------------------------

    Some commenters opposed to the rule asserted that the Commission, 
by providing the proposed exception in the rule, would relieve broker-
dealers of the fiduciary responsibility to clients that the Advisers 
Act imposes.\96\ Many of these commenters believed that, as a result, 
we would be denying fee-based brokerage customers an important investor 
protection. Investment advisers are fiduciaries by virtue of the nature 
of the position of trust and confidence they assume with their clients. 
They owe their clients ``an affirmative duty of `utmost good faith, and 
full and fair' disclosure of all material facts.'' \97\ In some cases, 
such as when broker-dealers assume positions of trust and confidence 
with their customers similar to those of advisers, broker-dealers have 
been held to similar standards.\98\ As we noted in our Reproposing 
Release, however, broker-dealers often play roles substantially 
different from investment advisers and in such roles they should not be 
held to standards to which advisers are held.\99\ Thus, we believe that 
broker-dealers and advisers should be held to similar standards 
depending not upon the statute under which they

[[Page 20434]]

are registered, but upon the role they are playing.
---------------------------------------------------------------------------

    \96\ AICPA Letter, supra note 31; CFA Letter, supra note 28; CFP 
Board Letter, supra note 28; FPA Letter, supra note 28; Fund 
Democracy Letter, supra note 28; NAPFA Letter, supra note 31. See 
also AICPA Sept. 22, 2004 Letter, supra note 21; CFA Jan. 13, 2000 
Letter, supra note 19; FPA Jan. 14, 2000 Letter, supra note 19.
    \97\ SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 
184 (1963) (quoting Prosser, LAW OF TORTS (1955), 534-35). See also 
Transamerica Mortgage Advisors, Inc. v. Lewis, 444 U.S. 11 (1979).
    \98\ See, e.g., Arleen W. Hughes, 27 S.E.C. 629 (1948) (noting 
that fiduciary requirements generally are not imposed upon broker-
dealers who render investment advice as an incident to their 
brokerage unless they have placed themselves in a position of trust 
and confidence), aff'd sub nom. Hughes v. SEC, 174 F.2d 969 (D.C. 
Cir. 1949); Leib v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 461 
F. Supp. 951 (E.D. Mich. 1978), aff'd, 647 F. 2d. 165 (6th Cir. 
1981) (recognizing that broker who has de facto control over non-
discretionary account generally owes customer duties of a fiduciary 
nature; looking to customer's sophistication, and the degree of 
trust and confidence in the relationship, among other things, to 
determine duties owed); Paine Webber, Jackson & Curtis, Inc. v. 
Adams, 718 P.2d. 508 (Colo. 1986) (evidence ``that a customer has 
placed trust and confidence in the broker'' by giving practical 
control of account can be ``indicative of the existence of a 
fiduciary relationship''); MidAmerica Federal Savings & Loan v. 
Shearson/American Express, 886 F.2d. 1249 (10th Cir. 1989) 
(fiduciary relationship existed where broker was in position of 
strength because it held its agent out as an expert); SEC v. 
Ridenour, 913 F.2d. 515 (8th Cir. 1990) (bond dealer owed fiduciary 
duty to customers with whom he had established a relationship of 
trust and confidence); C. Weiss, A Review of the Historic 
Foundations of Broker-Dealer Liability for Breach of Fiduciary Duty, 
23 Iowa J. Corp. Law 65 (1997). Cf. De Kwiatkowski v. Bear, Stearns 
& Co., 306 F.3d 1293, 1302-03, 1308-09 (2d Cir. 2002) (noting that 
brokers normally have no ongoing duty to monitor non-discretionary 
accounts but that ``special circumstances,'' such as a broker's de 
facto control over an unsophisticated client's account, a client's 
impaired faculties, or a closer-than-arms-length relationship 
between broker and client, might create extra-contractual duties).
    \99\ Reproposing Release, supra note 6, at n. 53-54 and 
accompanying text.
---------------------------------------------------------------------------

    We acknowledge that the lines between full-service broker-dealers 
and investment advisers continue to blur. But we do not believe 
requiring most or all full-service broker-dealers to treat most or all 
of their customer accounts as advisory accounts is an appropriate 
response to this blurring. Nor do we believe that Congress would have 
intended the Advisers Act to apply to all brokerage accounts receiving 
advice even when that advice is substantial. Congress did not mandate 
that the nature or amount of the advice rendered by broker-dealers 
remain static in order for broker-dealers to avail themselves of the 
statutory exception. Instead, Congress required only that such advice 
be performed ``solely incidental to'' a person's ``business as a broker 
or dealer'' and not for ``special compensation.'' The exception does 
not foreclose--but, instead, accommodates--the foreseeable likelihood 
that the ``business'' of broker-dealers, including the rendition of 
advice, would evolve. Thus, the emergence of these new fee-based 
brokerage accounts does not mean that broker-dealers have ceased to 
offer the general package of brokerage services they have traditionally 
provided to their customers or to dispense advice as part of that 
package.\100\
---------------------------------------------------------------------------

    \100\ For this reason, we disagree with the arguments of those 
commenters (e.g., Letter of CFP Board, supra note 28) that merely 
because the level and type of advisory services included in the 
package of brokerage services offered today may differ from what was 
provided in 1940, Congress could not have intended to except such 
services from the Advisers Act.
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    That is not to say, however, that broker-dealers can or should be 
``excluded from the purview of the Act merely because [they] are 
engaged in effecting market transactions.'' \101\ The rule we are 
adopting today provides for an exception to the definition of 
investment adviser for broker-dealers only in circumstances in which 
the Commission believes that Congress did not intend to apply the 
Advisers Act, and clarifies certain circumstances in which we believe 
the Advisers Act is intended to apply.\102\
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    \101\ Advisers Act Release No. 2, supra note 5.
    \102\ To the extent that statements made in Release Number 626 
may be interpreted to be inconsistent with our conclusion that 
excepting broker-dealers from the Advisers Act under the conditions 
established in the rule is consistent with the purposes of the Act, 
we reject them. See Advisers Act Release No. 626, supra note. At the 
time, we were not confronted with a situation in which broker-
dealers had, in fact, migrated toward providing brokerage services 
for compensation other than commissions. Today, they have done so 
(in a manner consistent with the findings of the Tully Report) and, 
after careful consideration of the congressional intent underlying 
the broker-dealer exception, we do not believe that the incremental 
benefit of applying protections unique to the Advisers Act to full-
service brokerage would justify applying the Act in circumstances in 
which Congress would have expected that the Act would not apply. See 
also discussion at Section III.E of this Release.
---------------------------------------------------------------------------

B. Exception for Fee-Based Brokerage Accounts

    Under rule 202(a)(11)-1(a), 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.\103\ The rule is available to any broker-dealer 
registered under the Exchange Act that satisfies two conditions: (i) 
Any investment advice it provides to an account must be solely 
incidental to the brokerage services provided to the account (and thus 
must be provided on a non-discretionary basis); \104\ and (ii) 
advertisements for and contracts, agreements, applications and other 
forms governing its accounts must include a prominent statement that 
the account is a brokerage account and not an advisory account, and 
that the broker-dealer's interests may not always be the same as the 
customer's. Customers would be encouraged to ask questions about their 
rights and the broker-dealer's obligations to them, including the 
extent of the broker-dealer's obligations to disclose conflicts of 
interest and to act in their best interest. This would include 
information about sales incentives and how a broker-dealer is 
compensated. In addition, the broker-dealer must identify an 
appropriate person at the firm with whom the customer can discuss the 
differences between brokerage and advisory accounts.\105\
---------------------------------------------------------------------------

    \103\ When the form of compensation demonstrates that the advice 
is not solely incidental to brokerage, however, as in the case of 
separate fees paid specifically for advice, the exception will not 
be available. See infra notes 144-147 and accompanying text.
    \104\ See Section III.E, infra.
    \105\ As reproposed, the rule contained a third condition: that 
the broker-dealer must not exercise investment discretion over the 
account from which it receives special compensation. See Reproposing 
Release, supra note 6. Because that condition is unnecessary, given 
our interpretation of ``solely incidental to'' as not including 
investment discretion, we have eliminated that condition from the 
rule we adopt today.
---------------------------------------------------------------------------

    A broker-dealer receiving special compensation for advisory 
services provided to customers must satisfy both of these requirements 
to avoid application of the Advisers Act. The failure of a broker-
dealer to meet either of the requirements of the rule will result in 
loss of the exception, and, unless another Advisers Act exception is 
available, the broker-dealer will likely violate one or more provisions 
of the Act.\106\
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    \106\ Broker-dealers should pay careful attention to their 
obligations in relying on this rule and the consequences of their 
failing to satisfy these obligations. The Advisers Act authorizes 
the Commission to bring administrative proceedings and initiate 
civil actions for violations of the Act. Advisers Act section 209.
---------------------------------------------------------------------------

1. Solely Incidental To
    Rule 202(a)(11)-1(a) includes the requirement, taken from the 
statutory broker-dealer exception, that advisory services provided in 
reliance on the rule must be solely incidental to the brokerage 
services provided.\107\ The rule provides that the advice a broker-
dealer provides to any account must be solely incidental to brokerage 
services provided by the broker-dealer to that account rather than to 
the overall operations of the broker-dealer. With that one difference, 
the Commission intends that this provision be interpreted consistently 
with the statutory provision, which is addressed in paragraph (b) of 
the rule and discussed in Section III.E of this document.
---------------------------------------------------------------------------

    \107\ Rule 202(a)(11)-1(a)(1)(i).
---------------------------------------------------------------------------

    As a result (and as proposed), the advice that a broker-dealer 
provides to fee-based brokerage accounts must be non-discretionary 
advice.\108\ Commenters favoring the rule generally agreed that 
discretionary accounts that are charged an asset-based fee should be 
subject to the Advisers Act.\109\ These accounts bear a strong 
resemblance to traditional advisory accounts, and it is highly likely 
that investors will perceive such accounts to be advisory accounts. 
Fee-based discretionary accounts were clearly the type of accounts that 
Congress understood would be covered by the Advisers Act when it passed 
the Act in 1940.
---------------------------------------------------------------------------

    \108\ See supra note 104.
    \109\ See, e.g., SIA Letter, supra note 29; Morgan Stanley 
Letter, supra note 29; Comment Letter of Investment Company 
Institute (Feb. 7, 2005) (``ICI Letter'').
---------------------------------------------------------------------------

2. Customer Disclosure
    As reproposed, rule 202(a)(11)-1(a) would have required that all 
advertisements for accounts excepted under the rule and all agreements, 
contracts, applications and other forms governing the operation of such 
accounts (``customer documents'') must contain a statement that the 
accounts are brokerage accounts and not advisory accounts. In addition, 
the reproposed rule would have required that the disclosure explain 
that the customer's rights and the firm's duties and obligations to the 
customer, including the scope of the firm's fiduciary

[[Page 20435]]

obligations, could differ. Finally, under the reproposed rule, broker 
dealers would have been required to identify an appropriate person at 
the firm with whom the customer could discuss the differences.\110\
---------------------------------------------------------------------------

    \110\ Reproposing Release, supra note 6.
---------------------------------------------------------------------------

    As reproposed, the disclosure was designed to put investors 
selecting a fee-based brokerage account on notice that their account is 
a brokerage account, with all the legal attributes of a brokerage 
account, rather than an advisory account. Only a few commenters were 
satisfied with the disclosure.\111\ Some commenters thought it should 
be ``strengthened'' by focusing on what these commenters considered a 
lack of investor protections associated with a broker-dealer 
relationship.\112\ Others expressed a great deal of skepticism about 
the ability of any disclosure to convey to investors the differences 
between broker-dealers' and advisers' legal obligations to clients in a 
reasonably succinct way because of the complexity of the issues.\113\
---------------------------------------------------------------------------

    \111\ ICI Letter, supra note 109; Morgan Stanley Letter, supra 
note 29; American Express Letter, supra note 33.
    \112\ FPA Letter, supra note 27; CFP Board Letter, supra note 
28; Joint Letter of Fund Democracy et al., supra note 28; ICAA 
Letter, supra note 28; AICPA Letter, supra note 31; T. Rowe Price 
Letter, supra note 28; Comment Letter of Government of the District 
of Columbia, Department of Insurance, Securities and Banking (Feb. 
23, 2005) (``D.C. Securities Bureau Letter''); AARP Letter, supra 
note 28.
    \113\ CFA Letter, supra note 28; NAPFA Letter, supra note 31; 
PIABA Letter, supra note 31; Comment Letter of TD Waterhouse (Feb. 
7, 2005) (``TD Waterhouse Letter'').
---------------------------------------------------------------------------

    Some commenters expressed concern about the usefulness of providing 
a contact person within the broker-dealer to aid investors with 
questions about the differences between investment advisers and broker-
dealers.\114\ They thought it would be very unlikely that such a person 
would accurately describe the differences in legal rights and 
obligations.\115\ Some of these commenters urged us to direct investors 
to a neutral source of information, such as the Commission's web site, 
for the information.\116\
---------------------------------------------------------------------------

    \114\ FPA Letter, supra note 27; CFP Board Letter, supra note 
28; Joint Letter of Fund Democracy et al., supra note 28; AICPA 
Letter, supra note 31; T. Rowe Price Letter, supra note 28; D.C. 
Securities Bureau Letter, supra note 112; PIABA Letter, supra note 
31; Comment Letter of the Consortium (Jan. 24, 2005) (``The 
Consortium Letter'').
    \115\ PIABA Letter, supra note 31; Northwestern Mutual Letter, 
supra note 29.
    \116\ FPA Letter, supra note 27; CFP Board Letter, supra note 
28.
---------------------------------------------------------------------------

    The federal securities laws place disclosure obligations on persons 
registered with us because they are in the best position to know what 
is and is not material to their circumstances. Like all registrants, 
broker-dealers are responsible for the accuracy and veracity of their 
statements. The legal obligations a broker-dealer owes to a customer 
vary from firm to firm and account to account depending upon such 
matters as the terms of the brokerage agreement, the state in which the 
broker-dealer is located, the SRO of which it is a member, the nature 
of the relationship between the broker-dealer and its customer, and the 
product the broker-dealer is selling.\117\ Thus, we believe broker-
dealers are in the best position to make the disclosures most 
appropriate to their customers.
---------------------------------------------------------------------------

    \117\ Some commenters echoed this concern. See, e.g., 
Northwestern Mutual Letter, supra note 29.
---------------------------------------------------------------------------

    Recently, we convened focus groups of investors to gauge the impact 
of this rule. Our investor focus groups found that the proposed 
disclosure statement alerted them to the fact that differences existed 
between brokerage accounts and advisory accounts,\118\ although the 
disclosure did not communicate what those distinctions might mean. 
Focus group participants viewed the terms such as ``duties,'' 
``rights'' and ``obligations'' as important terms that ``would prompt 
[them] to ask questions.'' \119\ The ability to contact a person at the 
broker-dealer was considered to be a positive factor.\120\ Focus group 
investors were, however, confused by the use of legal terms in the 
disclosure, including ``fiduciary,'' ``rights'' and ``obligations.'' 
They suggested using a ``plain-English'' approach that would avoid 
terms such as ``fiduciary'' and ``specify the actual differences 
between brokerage and advisory accounts.'' \121\
---------------------------------------------------------------------------

    \118\ Results of Investor Focus Group Interviews About Proposed 
Brokerage Account Disclosures, Report to the Securities and Exchange 
Commission, Siegel & Gale, LLC, Gelb Consulting Group, Inc. (Mar. 
10, 2005) at 4 (``Focus Group Report''). The Focus Group Report is 
available for viewing and downloading on the Internet at http://www.sec.gov/rules/proposed/s72599.shtml. Two other investor surveys 
were cited by commenters on the Reproposal. See TD Waterhouse 
Letter, supra note 113 (citing a survey conducted at the request of 
TD Waterhouse USA); Joint Letter of Fund Democracy et al., supra 
note 28 (citing a survey prepared for the Consumer Federation of 
America and the Zero Alpha Group) (available at http://www.zeroalphagroup.com/news/RIvestmentZAG_CFAFINAL_102704.ppt). 
Our focus group study differed in methodology from the CFA Survey 
and the TD Waterhouse survey. See infra notes 212-214 and 
accompanying text. Because of these differences, we discuss only our 
Focus Group Report.
    \119\ Id.
    \120\ Id.
    \121\ Id. at 4 & 9.
---------------------------------------------------------------------------

    We believe it is appropriate to inform broker-dealer customers of 
the nature of the account they are opening.\122\ At the same time, we 
are concerned about mandating detailed disclosure on complex legal 
issues, the outcome of which may vary depending upon the nature of the 
particular customer relationship. Our investor focus groups, however, 
indicated the need for some language that would help identify the 
actual differences between brokerage and advisory accounts. Thus, we 
believe it is most appropriate to emphasize that an investor's account 
is a brokerage account and not an advisory account, to provide some 
information on the nature of the conflicts inherent in the broker-
dealer relationship, and to encourage investors to ask questions about 
their rights and the broker-dealer's obligations to them. We are also 
mindful of the need for plain-English disclosure, and accordingly, we 
are making modifications to the disclosure language to help achieve 
that goal. As adopted, rule 202(a)(11)-1(a) now requires all customer 
documents to contain a clear, prominent statement \123\ as follows:
---------------------------------------------------------------------------

    \122\ The Commission expects to consider the broader broker-
dealer disclosure and sales practice concerns discussed in the 
reproposing release in the study discussed in section V of this 
Release.
    \123\ Some commenters suggested that the Commission establish 
minimum standards, including font size, for the disclosure 
statement. Rather than specify a particular size or placement for 
the disclosure, however, we believe that establishing general 
guidelines will be most effective. To be ''prominent,'' the 
statement should be included, at a minimum, on the front page of 
each document or agreement in a manner clearly intended to draw 
attention to it. In a televised or video presentation, a voice 
overlay must clearly convey the required information.

    Your account is a brokerage account and not an advisory account. 
Our interests may not always be the same as yours. Please ask us 
questions to make sure you understand your rights and our 
obligations to you, including the extent of our obligations to 
disclose conflicts of interest and to act in your best interest. We 
are paid both by you and, sometimes, by people who compensate us 
based on what you buy. Therefore, our profits, and our salespersons' 
---------------------------------------------------------------------------
compensation, may vary by product and over time.\124\

    \124\ Some commenters sought confirmation that they could tailor 
the language of the disclosure (see, e.g., Northwestern Mutual 
Letter, supra note 29). The rule is intended to be responsive to 
focus group investor concerns that all broker-dealers be required to 
use standard language. See Focus Group Report, supra note 118, at 9. 
We recognize, however, that it may be appropriate to make minor 
modifications to the language to fit individual circumstances. For 
example, in marketing material, it may be appropriate to substitute 
the name of the account, such as the ``ABC Account'' in lieu of 
``your account.'' The substance of the disclosure should not, 
however, be altered materially.
    The rule does not prohibit broker-dealers from providing 
additional disclosure materials discussing such matters as the 
nature of the fee-based account, customers' rights, the broker-
dealer's obligations, and the differences from an advisory account, 
so long as it does not interfere with the prominence of the 
disclosure statement and contact information. In addition, 
additional disclosure, interactive websites, or multimedia software 
cannot be used to substitute for the broker-dealer's obligation to 
provide a contact person under the rule. Of course, if a broker-
dealer were to choose to treat an account as an advisory account, 
the disclosure would not be required.

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[[Page 20436]]

Finally, broker-dealers must identify an appropriate person at the firm 
with whom the customer can discuss the differences between brokerage 
and advisory accounts.\125\
---------------------------------------------------------------------------

    \125\ The rule does not require the contact person to be 
specifically named; it is sufficient if a broker-dealer provides 
customers with a designated contact point that allows the customer 
to speak to a person within the firm who can answer customers' 
questions about the differences between fee-based brokerage accounts 
and advisory accounts. Because different broker-dealers will likely 
experience differences in the level and nature of customer inquiries 
and may choose differing approaches to responding efficiently within 
the firm's particular structure, we are not establishing 
qualifications or criteria for contact personnel at this time. Each 
broker-dealer is responsible for implementing and monitoring an 
approach designed to deliver answers that are accurate and not 
misleading.
---------------------------------------------------------------------------

    We are aware that this approach to disclosure of the nature of a 
brokerage account and the differences between such an account and an 
advisory account addresses many, but not all, concerns about investor 
confusion. As a consequence, as indicated in Section V of this Release, 
the Chairman has directed our staff to report to us regarding other 
options for addressing this confusion, including a study to consider, 
among other things, the need for additional investor education efforts 
and limits on broker-dealer marketing.

C. Discount Brokerage Programs

    Rule 202(a)(11)-1(a)(2), which we are adopting as proposed, 
provides that a broker-dealer will not be considered to have received 
special compensation solely because the broker-dealer charges one 
customer a commission, mark-up, mark-down or similar fee for brokerage 
services that is greater than or less than one it charges another 
customer.\126\ This provision is intended to keep a full-service 
broker-dealer from being subject to the Act solely because it also 
offers electronic trading or some other form of discount brokerage. 
Conversely, a discount broker-dealer would not be subject to the Act 
solely because it introduces a full-service brokerage program.
---------------------------------------------------------------------------

    \126\ Rule 202(a)(11)-1(a)(2).
---------------------------------------------------------------------------

    The rule supersedes staff interpretations under which a full-
service broker-dealer would be subject to the Act with respect to 
accounts for which it provides advice incidental to its brokerage 
business merely because it offers electronic trading or other forms of 
discount brokerage.\127\ These staff interpretations were not compelled 
by the Act and have led to the odd result that a full-service broker-
dealer cannot offer discount brokerage without treating its full-
service brokerage accounts as advisory accounts even though the 
services offered to those full-service accounts remained unchanged. 
Moreover, the staff interpretations create disincentives for full-
service broker-dealers to offer electronic or other types of discount 
brokerage, and may therefore limit customers' choices of the types of 
brokerage service they want from a broker-dealer, and may reduce 
competition in discount brokerage.\128\ The new rule makes a broker-
dealer's eligibility for the broker-dealer exception with respect to an 
account turn on the characteristics of that account and not other 
accounts. Commenters discussing this aspect of the proposed rule 
generally supported it.\129\
---------------------------------------------------------------------------

    \127\ See, e.g., Advisers Act Release No. 2, supra note 5.
    \128\ In 1978, our staff raised the possibility of such 
consequences and suggested, as a possible interpretation, the 
approach we are today adopting in this rule. See Advisers Act 
Release No. 626, supra note 6, at n.14.
    \129\ Merrill Lynch Letter, supra note 29; UBS Letter, supra 
note 29; Wachovia Letter, supra note 29. See also Federated Letter, 
supra note 31; Charles Schwab Sept. 22, 2004 Letter, supra note 17; 
Comment Letter of NASD (Feb. 24, 2000). But see D.C. Securities 
Bureau Letter, supra note 112.
---------------------------------------------------------------------------

D. Scope of Exception

    Rule 202(a)(11)-1(c) provides that a broker-dealer that is 
registered under the Exchange Act and registered under the Advisers Act 
would be 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.\130\ We received few comments 
regarding this provision of the rule, and we are adopting it as 
proposed.\131\ The provision codifies our earlier interpretation of the 
Act that permits a broker-dealer registered under the Advisers Act to 
distinguish its brokerage customers from its advisory clients.\132\
---------------------------------------------------------------------------

    \130\ Rule 202(a)(11)-1(c). Of course, applicability of the 
Advisers Act does not excuse the broker-dealer from compliance with 
the Exchange Act and its rules and applicable SRO requirements with 
respect to the account.
    \131\ See The Consortium Letter, supra note 114; PIABA Letter, 
supra note 31; UBS Letter, supra note 29.
    \132\ Proposing Release, supra note 6. See also Advisers Act 
Release No. 626, supra note 6.
---------------------------------------------------------------------------

E. Solely Incidental To

    As discussed above, the exceptions from the Advisers Act provided 
by section 202(a)(11)(C) and new rule 202(a)(11)-1 are available to 
broker-dealers only with respect to advice provided that is solely 
incidental to the broker-dealer's business (or, in the case of the 
rule, to the brokerage services provided to the account). In the 
Reproposing Release, we set forth our views on when advice is solely 
incidental to brokerage services and solicited comment on our 
interpretation of section 202(a)(11)(C). We also requested comment on 
our preliminary conclusions that certain advisory services did not 
appear to be solely incidental to brokerage services.
    In general, investment advice is ``solely incidental to'' the 
conduct of a broker-dealer's business within the meaning of section 
202(a)(11)(C) and to ``brokerage services'' provided to accounts under 
the rule when the advisory services rendered are in connection with and 
reasonably related to the brokerage services provided. This is 
consistent with the language Congress chose and the legislative history 
of the Advisers Act, including contemporaneous industry practice, which 
indicates Congress' intent to exclude broker-dealers providing advice 
as part of traditional brokerage services.\133\ It is also consistent 
with the Commission's contemporaneous construction of the Advisers Act 
as excepting broker-dealers whose investment advice is given ``solely 
as an incident of their regular business.'' \134\
---------------------------------------------------------------------------

    \133\ See supra notes 65-73 and accompanying text.
    \134\ Advisers Act Release No. 1 (emphasis supplied). See also 
Advisers Act Release No. 2, supra note 5; SEC 1941 Annual Report 
available at http://www.sechistorical.org/museum/papers/pdf/SEC_1941_AR.pdf (``Exempted from the provisions of the Act * * * are * 
* * brokers and security dealers whose investment advice is given 
solely as an incident of their regular business for which no special 
fee is charged.'').
---------------------------------------------------------------------------

    Several commenters, some of whom examined the statutory language 
\135\ and

[[Page 20437]]

legislative history themselves, disagreed with us. They urged us to 
adopt a very narrow view of the meaning of ``solely incidental to,`` 
arguing that it should include only advice that is provided on an 
``isolated,'' ``occasional,'' ``unpredictable''or ``limited'' 
basis,\136\ advice arising out of specific transactions,\137\ or advice 
that that is not marketed by a broker-dealer.\138\ We disagree with 
commenters for several reasons.
---------------------------------------------------------------------------

    \135\ We discussed the statutory language at length in the 
Reproposing Release. Some commenters took issue with our discussion 
of the language, calling it ``highly selective'' and ``strained,'' 
arguing that we have picked a secondary meaning of ``incidental'' 
and have ignored the word ``solely.'' See, e.g., Joint Letter of 
Fund Democracy et al., supra note 28; FPA Letter, supra note 27. 
According to The American Heritage Dictionary of the English 
Language (4th ed. 2000), ``solely'' means alone, singly, entirely, 
or exclusively. In combination then, and as discussed in the 
Reproposing Release, the phrase ``solely incidental to his business 
as a broker or dealer'' means exclusively following as a consequence 
of his ``business of effecting transactions in securities for the 
account of others'' (see Advisers Act section 202(a)(3) and Exchange 
Act section 3(a)(4)(A) defining ``broker'') or of his business of 
buying and selling securities for his own account (see Advisers Act 
section 202(a)(7) and Exchange Act section 3(a)(5)(A) defining 
``dealer''). We believe another (and simpler way) of saying the same 
thing is to say that the ``solely incidental to'' requirement means 
that the advisory services must be rendered in connection with and 
be reasonably related to the brokerage services provided. Although 
we acknowledge that there are other definitions of ``incidental,'' 
we believe that those definitions that indicate that the side 
occurrence (here the ``performance of [advisory] services'') is 
something that can be expected to arise in connection with the main 
action (here the ``business as a broker or dealer'') more closely 
reflect the pertinent historical practices of brokers and dealers 
than do those definitions that treat the side occurrence as 
something that merely happens ``by chance'' or on an ``isolated,'' 
``unpredictable'' and/or ``occasional'' basis. As we explain above, 
brokers do not render advice ``by chance'' or as ``an unpredictable 
or minor accompaniment'' of their businesses.
    \136\ See, e.g., FPA Letter, supra note 27; CFP Board Letter, 
supra note 28; Joint Letter of Fund Democracy et al., supra note 28; 
CFA Letter, supra note 28; AARP Letter, supra note 28.
    \137\ See, e.g., Joint Letter of Fund Democracy et al., supra 
note 28. See also CFA Letter, supra note 28; ICAA Letter, supra note 
28.
    \138\ See, e.g., Boyd Letter, supra note 28; CFA Letter, supra 
note 28; Joint Letter of Fund Democracy et al., supra note 28; FPA 
Letter, supra note 27; CFP Board Letter, supra note 28. See also 
T.Rowe Price Letter, supra note 28; ICAA Letter, supra note 28; 
Comment Letter of Austin Gallaher (Jan. 19, 2005) (``Gallaher 
Letter''); Comment Letter of Michael L. Jones (Jan. 20, 2005).
---------------------------------------------------------------------------

    First, the view that only minor, insignificant, or infrequent 
advice is excepted by section 202(a)(11)(C) misapprehends the 
historical background, including the legislative history of the 
Act.\139\ It fails to adequately appreciate the fact that the advice 
broker-dealers gave as part of their traditional brokerage services in 
1940 was often substantial in amount and importance to the 
customer.\140\ This has remained true throughout the following 
decades.\141\ Indeed, the importance of the broker-dealer's role as 
advice-giver in connection with brokerage transactions has shaped how 
we and the self-regulatory organizations have regulated and continue to 
regulate broker-dealers.\142\
---------------------------------------------------------------------------

    \139\ One commenter, for example, argued that our construction 
of ''solely incidental to'' in section 202(a)(11)(C) fails to take 
account of certain comments relating to the meaning of the exception 
for lawyers in section 202(a)(11)(B) made during the congressional 
testimony of Professor E. Merrick Dodd, which, the commenter argues, 
require a narrow construction of the broker-dealer exception. See 
CFA Letter, supra note 28 (citing testimony of Professor Dodd, 
Hearings on S. 3580, supra note 40, at 765-66). We disagree for 
several reasons. First, unlike the typical lawyer's business, a 
broker-dealer's business deals entirely with investments in 
securities, and the sort of investment advisory services that would 
be solely incidental to that business are logically broader than the 
sort of services that are solely incidental to the business of a 
lawyer. Second, the cited testimony appears to place few, if any, 
limits on the nature, extent, or duration of advisory services a 
lawyer might render and nevertheless be exempt from the Act, with 
the sole exception of a limit on holding out, which, given the 
securities-based nature of their business, cannot apply with equal 
force to broker-dealers. Finally, the commenter did not refer to 
other Congressional testimony suggesting that the ''solely 
incidental to'' limitation of section 202(a)(11)(B) embraces a 
substantial amount of advisory services and would result in 
extremely few lawyers who offer investment advice being subject to 
the Act. See Hearings on H.R. 10065, supra note 62, at 87; see also 
id. at 90. The view that the exception for lawyers--as well as the 
exceptions for broker-dealers and other professionals--made the Act 
inapplicable to most of the investment advice provided by these 
professionals was also expressed, without contradiction, by members 
of Congress during debate on the final version of the legislation. 
See 86 Cong. Rec. 9813 (Aug. 1, 1940) (statements of Reps. Hinshaw 
and Sabath).
    \140\ See supra notes 41-49 and accompanying text.
    \141\ See, e.g., Current Quotations on Stockbrokers, N.Y. Times, 
May 10, 1953, at SM19 (``[W]hen the Korean War began * * * 
[c]ustomers then wanted to know whether to expect confiscatory taxes 
that would reduce corporate profits, how price controls might effect 
their securities, and whether some businesses would be squeezed out 
entirely for lack of materials. `You have to talk to them,' one 
broker said. `Buying and selling is the least part of the service we 
give them for our commissions.' ''); SEC, SPECIAL STUDY OF THE 
SECURITIES MARKETS (1963) at 330 (``SPECIAL STUDY'') (``Both the 
volume and the variety of the written investment information and 
advice originated by broker-dealers, who for the most part furnish 
it free to their customers as part of their effort to sell 
securities, are impressive.''); id. at 386 (terming investment 
advice furnished by broker-dealers an ''integral part of their 
business of merchandising securities'' even if only ''incidental'' 
to that business); Interpretive Releases Relating to the Securities 
Exchange Act of 1934 and General Rules and Regulations Thereunder: 
Future Structure of Securities Markets (Feb. 2, 1972) [37 FR 5286, 
5290 (Mar. 14, 1972)] (``In our opinion, the providing of investment 
research is a fundamental element of the brokerage function for 
which the bona fide expenditure of the beneficiary's funds is 
completely appropriate, whether in the form of high commissions or 
outright cash payments.''); TULLY REPORT, supra note 12, at 3 (``The 
most important role of the registered representative is, after all, 
to provide investment counsel to individual clients, not to generate 
transaction revenues.'').
    \142\ For example, under the rules of self-regulatory 
organizations and consistent with Commission precedent, a broker 
must render advice that is based on a knowledge of the security 
involved and that is suitable for a customer in light of the 
customer's needs, financial circumstances, and investment 
objectives. E.g., NASD Rule 2310; NYSE Rule 405. In addition, under 
certain circumstances, such as when a broker-dealer assumes a 
position of trust and confidence similar to that of an adviser with 
its customer, it has been held to a fiduciary standard with its 
customer akin to that of an adviser and a client. See supra notes 
97-98 and accompanying text.
---------------------------------------------------------------------------

    Second, this narrow reading of section 202(a)(11)(C) urged by 
commenters would lead to brokers being required to treat many, if not 
most, full service brokerage accounts as advisory accounts, regardless 
of the nature of the compensation provided to the broker. Thus, it 
would extend the Advisers Act well beyond what we believe Congress 
intended when it enacted the broker-dealer exception.\143\
---------------------------------------------------------------------------

    \143\ Two commenters contended that our discussion of the 
purpose and scope of the broker-dealer exception is inconsistent 
with evidence that a ``significant'' reason for the Advisers Act was 
the need to regulate the investment advisory activities of broker-
dealers, which, the commenters argue, supports reading the exception 
very narrowly. See CFA Letter, supra note 28; FPA Letter, supra note 
27. In fact, the record shows that investment advisory services 
provided by broker-dealers simply were not a significant concern of 
those conducting the hearings on this legislation. See, e.g., 
Hearings on S. 3580, supra note 40, at 739. The statements on which 
the commenters rely, on balance, do not support their view that the 
Advisers Act was drafted to reach all but an insignificant amount of 
broker-dealer investment advice. Indeed, to the contrary, statements 
by members of Congress during debate on the final version of the 
legislation indicate that those members saw the exceptions in 
section 202(a)(11) as broadly excepting investment advice provided 
by broker-dealers and other professionals. See, e.g., 86 CONG. REC. 
9813 (Aug. 1, 1940) (statements of Reps. Hinshaw and Sabath).
---------------------------------------------------------------------------

    Finally, this narrow view would lead to results we believe even 
these commenters may not have intended. If a broker could give advice 
only infrequently (unless it registered under the Advisers Act), 
customers could not obtain advice in connection with each transaction 
they propose to make, even if that advice is simply seeking assurances 
of the wisdom of the proposed transaction. If a broker were permitted 
to give advice only in connection with a transaction, the broker 
(unless it registered under the Act) would be unable to advise clients 
to stay out of the market or to refrain from a particular transaction, 
or to provide generalized market reports to their clients. Yet brokers 
have long provided such advice as part of their traditional brokerage 
services, and continue to do so today. We do not believe that Congress 
in 1940, fully informed of then-extant brokerage practices, would have 
passed an exception from the Advisers Act that had such limited utility 
to broker-dealers.
    In a new section (b) of the rule, we are identifying three general 
circumstances under which we believe the provision of advisory services 
by a broker-dealer would not be solely incidental to brokerage. In 
addition, we are re-affirming our long-held view that advisory services 
provided by certain brokers in connection with wrap fee programs are 
not solely incidental to brokerage. As the rule makes clear, these are, 
of course, not an exclusive list of advisory services that are not 
solely incidental to brokerage and thus may lead to the loss of the 
broker-dealer exception.

[[Page 20438]]

1. Separate Contract or Fee
    Our rule contains a provision that a broker-dealer that separately 
contracts with a customer for investment advisory services (including 
financial planning services) cannot be considered to be providing 
advice that is solely incidental to its brokerage.\144\ A separate 
contract specifically providing for the provision of investment 
advisory services reflects a recognition that the advisory services are 
provided independent of brokerage services and, therefore, cannot be 
considered solely incidental to the brokerage services. Some commenters 
agreed that separate contracts provide a sensible approach to dealing 
with this issue.\145\
---------------------------------------------------------------------------

    \144\ Section 202(a)(11)-1(b)(1).
    \145\ See Northwestern Mutual Letter, supra note 29; Raymond 
James Letter, supra note 29.
---------------------------------------------------------------------------

    Similarly, advisory services are not solely incidental to brokerage 
services when those services are rendered for a separate fee. Charging 
a separate fee reflects the recognition that such services are provided 
independently of brokerage services and, therefore, cannot be 
considered to be solely incidental to brokerage services. Many 
commenters agreed with this approach.\146\ We understand that many 
broker-dealers already use the payment of a separate fee as a bright 
line test to distinguish their brokerage activities from their advisory 
activities.\147\
---------------------------------------------------------------------------

    \146\ See, e.g., The Consortium Letter, supra note 114; Merrill 
Lynch Letter, supra note 29; Raymond James Letter, supra note 29; 
SIA Letter, supra note 29. Some of the commenters further argued, 
however, that broker-dealers should be permitted to offer financial 
planning type services without registering under the Advisers Act if 
the customer does not pay a separate fee for such services. Merrill 
Lynch Letter, supra note 29; Raymond James Letter, supra note 29; 
SIA Letter, supra note 29.
    \147\ See, e.g., SIA Letter, supra note 29.
---------------------------------------------------------------------------

2. Financial Planning
    Under rule 202(a)(11)-1(b)(2), a broker-dealer would not be 
providing advice solely incidental to brokerage if it provides advice 
as part of a financial plan or in connection with providing planning 
services and: (i) holds itself out generally to the public as a 
financial planner or as providing financial planning services; \148\ or 
(ii) delivers to its customer a financial plan; or (iii) represents to 
the customer that the advice is provided as part of a financial plan or 
financial planning services. As a result, when the advice described 
above is provided, a broker-dealer that advertises (or otherwise 
generally lets it be known that it is available to provide) financial 
planning services must register under the Act (unless an exemption from 
registration is available). Further, a broker-dealer that provides such 
advice and delivers a financial plan to a customer or represents to a 
customer that its advice is provided as part of a financial plan or in 
connection with financial planning services must also register under 
the Act (unless another exemption from registration is available) and 
treat that customer as an advisory client.
---------------------------------------------------------------------------

    \148\ Under the rule, a broker-dealer would hold itself out as a 
financial planner if, for example, it (1) advertises financial 
planning services; (2) maintains a listing as a financial planner in 
a telephone or building directory; (3) lets it be known by word of 
mount or otherwise that new financial planning clients will be 
accepted; or (4) uses letterhead or business cares referring to 
financial planning services.
---------------------------------------------------------------------------

    Financial planning services typically involve assisting clients in 
identifying long-term economic goals, analyzing their current financial 
situation, and preparing a comprehensive financial program to achieve 
those goals. A financial plan generally seeks to address a wide 
spectrum of a client's long-term financial needs, including insurance, 
savings, tax and estate planning, and investments, taking into 
consideration the client's goals and situation, including anticipated 
retirement or other employee benefits.\149\ Typically, what 
distinguishes financial planning from other types of advisory services 
is the breadth and scope of the advisory services provided.
---------------------------------------------------------------------------

    \149\ See Advisers Act Release No. 1092, supra note 4 
(``Generally, financial planning services involve preparing a 
financial program for a client based on the client's financial 
circumstances and objectives. This information normally would cover 
present and anticipated assets and liabilities, including insurance, 
savings, investments, and anticipated retirement or other employee 
benefits. The program developed for the client usually includes 
general recommendations for a course of activity, or specific 
actions, to be taken by the client. For example, recommendations may 
be made that the client obtain insurance or revise existing 
coverage, establish an individual retirement account, increase or 
decrease funds held in savings accounts, or invest funds in 
securities. A financial planner may develop tax or estate plans for 
clients or refer clients to an accountant or attorney for these 
services.'').
---------------------------------------------------------------------------

    Although most financial planners are registered under the Advisers 
Act or similar state statutes, financial planners today belong to a 
distinct profession, and financial planning is a separate discipline 
from, for example, portfolio management.\150\ This development has 
occurred only relatively recently, over approximately the last twenty-
five years--well after the enactment of the Investment Advisers Act in 
1940.\151\
---------------------------------------------------------------------------

    \150\ See, Conrad S. Ciccotello et al., Will Consult For Food! 
Rethinking Barriers To Professional Entry In The Information Age, 40 
AM. BUS. L.J. 905 (2003) (``Barriers to Professional Entry'') at 921 
(``Personal financial planning as a distinct profession is quite 
new''). Cf. Clifford E. Kirsch, INVESTMENT ADVISER REGULATION (May 
2004) (``INVESTMENT ADVISER REGULATION'') at Sec.  2:5.1 (``Even 
though the financial community distinguishes between financial 
planners and investment advisers * * * financial planners generally 
fall within the definition of section 202(a)(11) and are required to 
register as advisers'').
    \151\ See Jeffrey H. Rattiner, GETTING STARTED AS A FINANCIAL 
PLANNER at 1-6 (2000); Barriers to Professional Entry, supra, note 
150. See also FINANCIAL PLANNERS, SEC Staff Report to Subcommittee 
on Telecommunications and Finance of the House Committee on Energy 
and Commerce (Feb. 12, 1988) at 6-7 (noting an increase in the 
number of people engaged in financial planning).
---------------------------------------------------------------------------

    In the Reproposing Release, we expressed the view that the advisory 
services provided by financial planners and the context in which they 
are provided may extend beyond what Congress, in 1940, reasonably could 
have understood broker-dealers to have provided as an advisory service 
ancillary to their brokerage business.\152\ Moreover, we expressed 
concern that some broker-dealers may have promoted ``financial 
planning'' as a way of acquiring the confidence of investors and then 
offered their brokerage services without providing any meaningful 
financial planning services. We asked for comment on whether we should 
take an interpretive position that advice provided in connection with 
financial planning was not solely incidental to brokerage.\153\
---------------------------------------------------------------------------

    \152\ Reproposing Release, supra note 6, at n.113.
    \153\ Our staff has previously expressed the view that advice 
provided in connection with financial planning is not solely 
incidental to brokerage. See, e.g., Townsend and Associates, SEC 
Staff No-Action Letter (Sept. 21, 1994) (advice is not incidental 
that is provided ``as part of an overall financial plan that 
addresses the financial situation of a customer and formulates a 
financial plan.''). See also Investment Management & Research, Inc., 
SEC Staff No-Action Letter (Jan. 27, 1977). It is also consistent 
with views expressed in two of the leading treatises on investment 
advisers. See Thomas P. Lemke & Gerald T. Lins, REGULATION OF 
INVESTMENT ADVISERS Sec.  1:20 (2004); INVESTMENT ADVISER 
REGULATION, supra note 150 at Sec.  2:5:1. It may, however, be 
inconsistent with statements made in a few of our staff's other 
letters. See, e.g., Nathan & Lewis Securities, SEC Staff No-Action 
Letter (Mar. 3, 1988) (``Nathan & Lewis No-Action Letter''); Elmer 
D. Robinson, SEC Staff No-Action Letter (Dec. 6, 1985).
---------------------------------------------------------------------------

    We received many comment letters from firms and individuals with 
strongly held views on this topic. Advisers, financial planners, and 
investor groups asserted that financial planning was not solely 
incidental to brokerage.\154\ Broker-dealers, on the other hand, argued 
that financial planning was an integral part of full-service brokerage, 
and that our proposed interpretation may interfere with broker-dealers' 
suitability obligations.\155\ Some

[[Page 20439]]

commenters were concerned that if the applicability of the Act turned 
on whether a broker-dealer held itself out as being a financial 
planner, broker-dealers would simply use a slightly different title, 
such as ``financial consultant,'' to create the same impression in the 
minds of investors.\156\
---------------------------------------------------------------------------

    \154\ See, e.g., FPA Letter, supra note 27; CFA Letter, supra 
note 28; Joint Letter of Fund Democracy et al., supra note 28; CFP 
Board Letter, supra note 28; AICPA Letter, supra note 31; T. Rowe 
Price Letter, supra note 28; ICAA Letter, supra note 28; ICI Letter, 
supra note 109.
    \155\ See, e.g., SIA Letter, supra note 29; Merrill Lynch 
Letter, supra note 29; Northwestern Mutual Letter, supra note 29; 
Wachovia Letter, supra note 29; CGMI Letter, supra note 29. At least 
one broker-dealer commenter, however, argued that financial planning 
services are unconnected from any securities transaction, are not 
solely incidental, and therefore should be provided only in accounts 
subject to full investment advisory registration. TD Waterhouse 
Letter, supra note 113.
    \156\ See, e.g., CFP Board Letter, supra note 28; FPA Letter, 
supra note 27.
---------------------------------------------------------------------------

    We do not believe that financial planning, as it is understood 
today, necessarily follows as a consequence of rendering brokerage 
services. Instead, it is a relatively new service that many brokers 
provide in a manner essentially independent of their brokerage 
services. That being said, and as we acknowledged in the Reproposing 
Release, elements of financial planning have been, are, and should be a 
part of every broker-dealer's considerations as to the suitability of 
their recommendations. We have concluded that it would be unwise for us 
to attempt to distinguish when a suitability analysis ends and 
financial planning begins, and we do not want to interfere in any way 
with a broker-dealer's fulfillment of its suitability obligations.
    We have determined instead to rely primarily on how a broker-dealer 
holds itself out to the public and its customers in distinguishing the 
advice provided in connection with financial planning from other types 
of investment advice, such as transaction-specific advice, which may be 
solely incidental to brokerage.\157\ Our experience generally informs 
us that investors understand financial plans and financial planning to 
mean something different from brokerage. Our investor focus groups 
showed that investors were confused about the differences among 
financial service providers generally, but in many cases understood 
financial planning to be a separate category, and assumed financial 
planners held responsibilities relating to the long-term needs of their 
clients.\158\ Moreover, our approach would provide broker-dealers the 
certainty they need to determine when their advisory activities will 
trigger obligations under the Advisers Act because they can control how 
they hold themselves out to the public and their customers.
---------------------------------------------------------------------------

    \157\ However, we do go beyond focusing exclusively on ``holding 
out'' as a determining factor, and also include a restriction on 
financial planning activity, when we include the delivery of a 
financial plan as not solely incidental to brokerage. We do so 
because, even though this restriction may, in certain circumstances, 
result in limiting a broker-dealer's ''financial planning'' 
activity, this restriction addresses another form of holding out. 
The delivery of a financial plan to a customer demonstrates to the 
customer that the broker-dealer is offering its financial planning 
services, and thus delivery has the same effect as other forms of 
holding out. Accordingly, we have concluded that, on balance, this 
type of financial planning activity should also be restricted.
    \158\ Focus Group Report, supra note 118, at 2, 9 & 13. Many 
focus group participants perceived that financial planning involved 
separate and distinct services, in addition to services that other 
financial service professionals might provide.
---------------------------------------------------------------------------

    Under the rule, a broker-dealer would be subject to the Advisers 
Act if it portrays itself to the public as a financial planner or as 
providing financial planning services, whether it uses those particular 
terms or not. And it must treat as advisory clients all those customers 
to whom it delivers a financial plan, regardless of what it chooses to 
call the plan. While we have recognized there are some common elements 
in a financial plan and a broker-dealer's advice based on its 
understanding of a customer's needs and objectives, which is incumbent 
in its suitability analysis, we do no not consider this broker-dealer 
advice alone as constituting a financial plan.
    The broker-dealer must also treat as advisory clients those 
customers to whom it represents that its advice is part of a financial 
plan even if it uses some other term to describe the plan.\159\ Whether 
a particular document is, under the rule, a financial plan will turn on 
whether the document or representation bears the characteristics of a 
financial plan. Whether a communication represents that the services 
provided are financial planning services will depend on how a 
reasonable investor would understand the services described in the 
communication.\160\
---------------------------------------------------------------------------

    \159\ The rule would not, however, require broker-dealers to 
treat as an advisory client a customer to whom it merely makes known 
that financial planning services are available but to whom it does 
not provide such services.
    \160\ Including a disclaimer that comprehensive advisory 
services offered to customers would not constitute ``financial 
planning services'' or is ``not comprehensive'' would not permit a 
broker-dealer to avoid application of the Advisers Act under the 
rule.
---------------------------------------------------------------------------

3. Holding Out
    We have decided not to include in rule 202(a)(11)-1 any other 
limitations on how a broker-dealer may hold itself out or titles it may 
employ without complying with the Advisers Act. Many commenters argued 
that we should prohibit broker-dealers from calling themselves 
financial advisors, financial consultants or other similar names. These 
commenters asserted such titles are inconsistent with the broker-dealer 
exception for advice that is solely incidental to brokerage.\161\ Other 
commenters, however, argued that, in many instances, such titles are 
fully consistent with the services provided to brokerage customers, 
whether fee-based or commission-based, and should not be 
proscribed.\162\
---------------------------------------------------------------------------

    \161\ See, e.g., T. Rowe Price Letter, supra note 28; CFA 
Letter, supra note 28; Joint Letter of Fund Democracy et al., supra 
note 28; ICAA Letter, supra note 28; The Consortium Letter, supra 
note 114; Gallaher Letter, supra note 138; Comment Letter of Daniel 
H. Foster (Jan. 17, 2005); Comment Letter of Meyer Advisory Services 
(Feb. 7, 2005); Comment Letter of Shawbrook (Feb. 7, 2005).
    \162\ See, e.g., Merrill Lynch Letter, supra note 29; Morgan 
Stanley Letter, supra note 29. See also Northwestern Mutual Letter, 
supra note 29; Raymond James Letter, supra note 29; Wachovia Letter, 
supra note 29.
---------------------------------------------------------------------------

    The statutory broker-dealer exception is a recognition by Congress 
that a broker-dealer's regular activities include offering advice that 
could bring the broker-dealer within the definition of investment 
adviser, but which should nonetheless not be covered by the Act. The 
terms ``financial advisor'' and ``financial consultant,'' for example, 
are descriptive of such services provided by broker-dealers. As part of 
their ongoing business, full service broker-dealers consult with or 
advise customers as to their finances. Indeed, terms such as 
``financial advisor'' and ``financial consultant'' are among the many 
generic terms that describe what various persons in the financial 
services industry do, including banks, trust companies, insurance 
companies, and commodity professionals. Moreover, we are concerned that 
any list of proscribed names we develop could lead to the development 
of new ones with similar connotations.
    We believe the better approach, which we are adopting today, is to 
require broker-dealers to inform clients clearly that they are entering 
into a brokerage, and not an advisory, relationship. The customer 
disclosure requirements, which we discuss above, must be included in 
all customer documents for fee-based brokerage accounts. We encourage 
brokers to consider making similar disclosure in other 
communications.\163\
---------------------------------------------------------------------------

    \163\ See also Sections I and V of this Release for additional 
steps that may be taken in the future to address issues of investor 
confusion and broker-dealer marketing.
---------------------------------------------------------------------------

4. Discretionary Asset Management
    Under the rule we adopt today, discretionary investment advice is 
not ``solely incidental to'' brokerage services within the meaning of 
the rule (or to the business of a broker-dealer within the meaning of 
section 202(a)(11)(C)) and,

[[Page 20440]]

accordingly, brokers and dealers are not excepted from the Act for any 
accounts over which they exercise investment discretion as that term is 
defined in section 3(a)(35) of the Exchange Act \164\ (except that 
investment discretion granted by a customer on a temporary or limited 
basis is excluded). The rule terminates the existing staff approach, 
under which a discretionary account is subject to the Act only if the 
broker-dealer has enough other discretionary accounts to trigger the 
Act.\165\ Under the new rule, the exception provided by section 
202(a)(11)(C) is unavailable for any account over which a broker-dealer 
exercises investment discretion, regardless of the form of compensation 
and without regard to how the broker-dealer handles other 
accounts.\166\
---------------------------------------------------------------------------

    \164\ 15 U.S.C. 78c(a)(35). Under section 3(a)(35) of the 
Exchange Act, a person exercises ``investment discretion'' with 
respect to an account if, ``directly or indirectly, such person (A) 
is authorized to determine what securities or other property shall 
be purchased or sold by or for the account, (B) makes decisions as 
to what securities or other property shall be purchased or sold by 
or for the account even through some other person may have 
responsibility for such investment decisions, or (C) otherwise 
exercises such influence with respect to the purchase and sale of 
securities or other property by or for the account as the 
Commission, by rule, determines, in the public interest or for the 
protection of investors, should be subject to the operation of the 
provisions of this title and the rules and regulations thereunder.'' 
Of course, such discretionary accounts continue to be subject to the 
Exchange Act and SRO rules.
    \165\ As we stated in our Reproposing Release, we believe that 
an account-by-account approach is preferable for several reasons. 
First, it better ensures that the Advisers Act is applied to 
customers who have the sort of relationship with a broker-dealer 
that the Commission has long recognized the Act was intended to 
reach. Second, it is consistent with the longstanding view that a 
broker-dealer is an investment adviser only with respect to those 
accounts for which the broker-dealer provides services or receives 
compensation that subject the broker-dealer to the Act. Third, 
unlike the existing staff approach, the new rule provides a bright-
line test for the availability of the section 202(a)(11)(C) 
exception, and thereby gives clarity to that provision at a time 
when, as we have discussed previously, the line between advisory and 
brokerage services is blurring and the original ``bright line''--
``special compensation''--has ceased to function as a reliable 
indicator of the services the Act was designed to reach. Finally, 
the new rule results in all discretionary accounts being treated as 
advisory accounts without regard to the form of compensation and is 
therefore consistent with the design of rule 202(a)(11)-1 as a 
whole. Reproposing Release, supra note 6.
    \166\ The fact that discretionary brokerage accounts and 
financial planning services are subject to the Advisers Act does not 
affect the obligation of a person engaged in the business of 
effecting transactions in securities from registering as a broker-
dealer under section 15(a) of the Exchange Act. To the extent that 
broker-dealer registration has previously been required, it will 
continue to be required.
---------------------------------------------------------------------------

    We believe that a broker-dealer's authority to effect a trade 
without first consulting a client is qualitatively distinct from simply 
providing advice as part of a package of brokerage services. When the 
broker-dealer has discretion, it is not only the source of advice, it 
is also the person with the authority to make investment decisions 
relating to the purchase or sale of securities on behalf of the broker-
dealer's clients. This quintessentially supervisory or managerial 
character warrants the protection of the Advisers Act because of the 
``special trust and confidence inherent'' in such relationships.\167\ 
Most commenters addressing the issue, including those representing 
investors,\168\ advisers,\169\ broker-dealers,\170\ and others,\171\ 
generally agreed with us.
---------------------------------------------------------------------------

    \167\ Amendment and Extension of Temporary Exemption From the 
Investment Advisers Act for Certain Brokers and Dealers, Investment 
Advisers Act Release No. 471 (Aug. 20, 1975) [40 FR 38156 (Aug. 27, 
1975).
    \168\ See, e.g., CFA Letter, supra note 28; Joint Letter of Fund 
Democracy et al., supra note 28; AARP Letter, supra note 28.
    \169\ See, e.g., ICAA Letter, supra note 28; T. Rowe Price 
Letter, supra note 28; CFP Board Letter, supra note 28; Comment 
Letter of 1st Global Capital Corporation (Feb. 7, 2005); Comment 
Letter of Ken Kessler (Feb. 8, 2005).
    \170\ See, e.g., TD Waterhouse Letter, supra note 113; Merrill 
Lynch Letter, supra note 29; Morgan Stanley Letter, supra note 29; 
Wachovia Letter, supra note 29; NASD Letter, supra note 29; American 
Express Letter, supra note 33; Comment Letter of Farm Creek 
Securities (Feb. 7, 2005).
    \171\ See, e.g., AICPA Letter, supra note 31; D.C. Securities 
Bureau Letter, supra note 112; PIABA Letter, supra note 31.
---------------------------------------------------------------------------

    One commenter who disagreed with this provision disputed our 
interpretation of the Act. This commenter argued that Congress must 
have been aware that broker-dealers exercised discretionary authority 
over commission-based accounts and, by not expressly stating that 
brokers offering such accounts were subject to the Act, Congress 
indicated its intent to except such broker-dealers from the Act.\172\ 
We disagree. The Advisers Act does not address directly whether a 
broker-dealer exercising investment discretion over a commission-based 
account must comply with the Act. The Act applies unless the advisory 
services are ``solely incidental to'' the broker-dealer's business and 
no special compensation is received. Whether the exercise of investment 
discretion meets the requirements of the exception depends on the sort 
of analysis and judgment that we have made in this rulemaking.
---------------------------------------------------------------------------

    \172\ Morgan, Lewis Letter, supra note 36.
---------------------------------------------------------------------------

    This commenter also suggested that our failure to assert the 
applicability of the Act to commission-based discretionary accounts in 
the past, implicitly supports the view that the Act should not apply to 
such accounts.\173\ As we explained in the Reproposing Release, 
however, we have previously expressed concern that brokerage 
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.'' \174\ 
Although we determined not to take action in the past on whether 
discretionary accounts should be treated as advisory accounts, we 
explained that our staff would continue to examine the applicability of 
the federal securities laws to discretionary accounts. Our 
determination that the Act applies to all accounts over which broker-
dealers exercise investment discretion (with certain exceptions) 
instead of only to the discretionary accounts of those broker-dealers 
whose accounts are almost exclusively discretionary (the staff's 
position since 1978) follows that examination and is based on the 
reasons stated above and in the Reproposing Release. We are not 
persuaded by certain commenters' challenge to our determination 
relating to discretionary commission-based accounts. Indeed, in 
criticizing our determination that the exercise of investment 
discretion cannot be ``solely incidental to'' a broker-dealer's 
business, one commenter acknowledges that (apart from the circumstances 
the commenter identifies) the exercise of investment discretion ``would 
typically be viewed by customers as investment supervisory services 
where the broker-dealer or investment adviser makes decisions 
constrained only by investment guidelines or a description of the 
investment strategy.'' \175\
---------------------------------------------------------------------------

    \173\ Id.
    \174\ Advisers Act Release No. 626, supra note 6.
    \175\ See Morgan, Lewis Letter, supra note 36.
---------------------------------------------------------------------------

    We remain unable to conclude that in 1940 Congress would have 
understood investment discretion to be part of the traditional package 
of services broker-dealers offered for commissions.\176\ We

[[Page 20441]]

are aware of nothing in the legislative history of section 
202(a)(11)(C) (or of the Act as a whole) or in the brokerage practices 
in 1940 that would preclude our interpretation of that section as being 
unavailable for all accounts over which broker-dealers exercise 
investment discretion.\177\ Given the inherently managerial nature of 
investment discretion, we see no reason why Congress, as a general 
matter, would have intended to exclude such services from the reach of 
the Advisers Act.
---------------------------------------------------------------------------

    \176\ One commenter challenged our statement in the Reproposing 
Release that, in the decade before the enactment of the Advisers 
Act, the NYSE had significantly restricted broker-dealers' exercise 
of investment discretion, arguing that the NYSE had merely acted to 
ensure proper supervision of such discretionary accounts. See 
Morgan, Lewis Letter, supra note 36. Not only did the NYSE in 1930 
limit the individuals within broker-dealer firms who could exercise 
investment discretion, however, but it also subsequently further 
restricted such accounts by requiring firms wishing to have any 
employee exercise discretion over a customer's account (with limited 
exceptions) to obtain the specific prior approval of the NYSE's 
Committee on Member Firms. See NYSE Directory and Guide (1938), at 
C-359 (Rule 513). In addition to the NYSE's progressively more 
restrictive approach to such accounts, contemporary literature 
reflected the view that the exercise of broad investment discretion 
by broker-dealers--though not illegal in certain circumstances--was 
viewed by courts and respected firms within the brokerage industry 
with suspicion and disapproval. See, e.g., Wall Street, supra note 
37, at 241; Security Markets, supra note 39, at 649-50; Charles H. 
Meyer, The Law of Stock Brokers and Stock Exchanges (1931) at 306.
    \177\ One commenter maintained that the legislative history 
showed that Congress was fully aware that broker-dealers were 
exercising investment discretion over commission-based accounts and 
not principally in the accounts they handled through their separate 
investment advisory departments. See Morgan, Lewis Letter, supra 
note 36. In our view, however, neither of the two documents in the 
legislative record on which the commenter relies supports this 
assertion. The commenter appears to assume that simply because a 
broker-dealer's customer paid commissions for executions of trades, 
that customer may not also have received investment advisory 
services related to those same trades (including the exercise of 
investment discretion) for a fee from a special advisory department 
of the same broker-dealer. But the Illinois Legislative Council 
Report to which the commenter refers was addressing circumstances in 
which the advisory departments of broker-dealers were paid a fee for 
advice, and then those departments advised the purchase or sale of 
securities for which the same broker-dealer firm also received 
commissions (or mark-ups or markdowns). See Illinois Legislative 
Council Report, supra note 66, at 1008, 1010, 1014. The same is true 
of the excerpt that the commenter quotes from a memorandum by the 
Commission's then General Counsel, which was included in the 
legislative record. See Memorandum: Federal Power to Regulate 
Investment Advisers (S. 3580, Title II) (reprinted in Hearings on S. 
3580, supra note 40, at 1024).
---------------------------------------------------------------------------

    Several commenters, however, persuade us that defining 
``discretionary authority'' by reference to section 3(a)(35) of the 
Exchange Act, would as a practical matter preclude many forms of 
limited discretion commonly exercised by broker-dealers assisting 
customers with otherwise non-discretionary brokerage accounts.\178\ We 
believe that such an effect would not benefit brokerage customers, nor 
would it be necessary to achieve the purpose of the rule. Therefore, 
the final rule permits broker-dealers to exercise investment discretion 
on a temporary or limited basis without becoming ineligible for the 
exception under the rule.\179\ In such cases, the customer is granting 
discretion primarily for execution purposes and is not seeking to 
obtain discretionary supervisory services. Such discretion must be 
limited to a transaction or series of transactions and not extend to 
setting investment objectives or policies for the customer. For 
example, we would view a broker-dealer's discretion to be temporary or 
limited within the meaning of rule 202(a)(11)-1(d) when the broker-
dealer is given discretion:
---------------------------------------------------------------------------

    \178\ See, e.g., SIA Letter, supra note 29; UBS Letter, supra 
note 29; CGMI Letter, supra note 29. See also Morgan, Lewis Letter, 
supra note 36.
    \179\ Rule 202(a)(11)-1(d).
---------------------------------------------------------------------------

     As to the price at which or the time to execute an order 
given by a customer for the purchase or sale of a definite amount or 
quantity of a specified security;
     On an isolated or infrequent basis, to purchase or sell a 
security or type of security when a customer is unavailable for a 
limited period of time not to exceed a few months; \180\
---------------------------------------------------------------------------

    \180\ For example, a customer may be on vacation or otherwise 
unavailable for a short period of time and provide specific 
instructions as to the handling of his account during this time.
---------------------------------------------------------------------------

     As to cash management, such as to exchange a position in a 
money market fund for another money market fund or cash equivalent;
     To purchase or sell securities to satisfy margin 
requirements;
     To sell specific bonds and purchase similar bonds in order 
to permit a customer to take a tax loss on the original position;
     To purchase a bond with a specified credit rating and 
maturity; and
     To purchase or sell a security or type of security limited 
by specific parameters established by the customer.\181\
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    \181\ A broker-dealer may purchase or sell a particular 
security, so long as all relevant material strategic features (e.g., 
type of issuer, amount, maturity and yield) are specified by the 
client.
---------------------------------------------------------------------------

5. Wrap Fee Sponsorship
    Broker-dealers often serve as sponsors of wrap fee programs, under 
which broker-dealers effect securities transactions for one or more 
portfolio managers, which may be independent investment advisers. The 
sponsoring broker-dealer may provide wrap fee program clients with 
asset allocation models or with advice about selecting one or more of 
the portfolio managers in the program. The portfolio managers typically 
have discretionary authority over the client's assets. Traditionally, 
we have not viewed the sponsor's asset allocation or portfolio manager 
selection advice as incidental to the brokerage transactions initiated 
by the portfolio manager and executed by the sponsor.\182\ In our 
Reproposing Release, however, we asked whether such broker-dealers may 
have available the exception provided by rule 202(a)(11)-1 if, among 
other things, the portfolio manager selection and asset allocation 
services could be viewed as solely incidental to the sponsor's business 
of brokerage.\183\ Commenters urged the Commission to reaffirm its 
interpretation that portfolio manager selection and asset allocation 
services involved in wrap fee programs are advisory services that are 
not solely incidental to brokerage services,\184\ and we do so here 
today.
---------------------------------------------------------------------------

    \182\ We have viewed broker-sponsored wrap fee programs as being 
subject to the Advisers Act. Disclosure by Investment Advisers 
Regarding Wrap Fee Programs, Investment Advisers Act Release No. 
1401 (Jan. 13, 1994) [59 FR 3033 (Jan. 20, 1994)], at n.2 (proposing 
amendments to Form ADV); Investment Advisers Act Release No. 1411 
(Apr. 19, 1994) (adopting amendments to Form ADV) [59 FR 21657 (Apr. 
26, 1994)].
    \183\ Reproposing Release, supra note 6.
    \184\ AICPA Letter, supra note 31; The Consortium Letter, supra 
note 114; Fund Democracy Letter, supra note 28; ICI Letter, supra 
note 109; ICAA Letter, supra note 28; T. Rowe Price Letter, supra 
note 28.
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IV. Effective and Compliance Dates

    Rule 202(a)(11)-1 is effective April 15, 2005, except that 
paragraph (a)(1)(ii) of the rule is effective May 23, 2005. Consistent 
with the Administrative Procedures Act, the effective date of rule 
202(a)(11)-1 is less than 30 days after publication because the rule 
recognizes an exemption, relieves a restriction, and contains 
interpretative rules.\185\ In addition, the Commission for good cause 
finds that an effective date later than April 15, 2005 is 
impracticable, unnecessary and contrary to the public interest because, 
among other things, temporary rule 202(a)(11)T will expire on that 
date.\186\ Beginning on April 15, 2005, broker-dealers may rely on rule 
202(a)(11)-1(a)(2) when they offer discount brokerage accounts excluded 
under the rule. Also beginning on April 15, 2005, broker-dealers may 
rely on rule 202(a)(11)-1(a)(1) to provide non-discretionary investment 
advice in conjunction with fee-based brokerage accounts excluded under 
the rule. Broker-dealers relying on rule 202(a)(11)-1(a)(1) must comply 
with the disclosure requirements of paragraph (a)(1)(ii) by July 22, 
2005. All advertisements for, and contracts, agreements, applications 
and other forms governing accounts opened after July 22, 2005 in 
reliance on rule 202(a)(11)-1(a)(1) must include the disclosure 
required by paragraph (a)(1)(ii). Broker-dealers relying on rule 
202(a)(11)-1(a)(1) with respect to fee-based brokerage accounts opened 
prior to July 22, 2005 are not required to

[[Page 20442]]

amend existing contracts and agreements governing those accounts.\187\
---------------------------------------------------------------------------

    \185\ See 5 U.S.C. 553(d)(1) and (d)(2).
    \186\ See 5 U.S.C. 553(d)(3).
    \187\ We nevertheless encourage broker-dealers opening fee-based 
accounts for customers in reliance on the rule after April 15, 2005 
but before July 22, 2005, to include with respect to those accounts 
the disclosure required by rule 202(a)(11)-1(a)(1)(ii).
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    With respect to paragraph (b)(3) of rule 202(a)(11)-1, which 
provides that exercising investment discretion is not ``solely 
incidental to'' brokerage services within the meaning of section 
202(a)(11)(C) of the Advisers Act, broker-dealers must treat 
commission-based discretionary accounts as advisory accounts no later 
than October 24, 2005. With respect to paragraphs (b)(1) and (b)(2) of 
rule 202(a)(11)-1, broker-dealers must treat as advisory accounts those 
accounts to which the broker-dealer provides advice in the 
circumstances described in paragraphs (b)(1) and (b)(2) no later than 
October 24, 2005.

V. Further Examination of Issues

    As we noted at the beginning of this release, this rulemaking has 
raised a number of important issues, implicating policy concerns well 
beyond the scope of this rulemaking. Although we have concluded that 
this rulemaking is not the appropriate mechanism for resolving these 
concerns, we are committed to pursuing the most effective solutions to 
these vital issues. Accordingly, the Chairman, after consulting with, 
and considering the views of, the entire Commission, has directed the 
Commission staff to report within 90 days on ways in which these issues 
could be addressed. The staff is to provide a detailed description or 
outline of any rulemaking action that the staff would be prepared to 
recommend that the Commission undertake in the near term, or to 
recommend that the Commission ask the NASD or other SROs to undertake 
in the near term. The staff is also to report on options and 
recommendations for a study to compare the levels of protection 
afforded retail customers of financial service providers under the 
Securities Exchange Act and the Investment Advisers Act, and to 
recommend ways to address any investor protection concerns arising from 
material differences between the two regulatory regimes. The scope of 
the study would include, but not necessarily be limited to, questions 
such as:
     Should the Commission seek legislation that would 
integrate the existing regulatory schemes applicable to broker-dealers 
and investment advisers that provide services to retail clients?
     Should sales practice standards and advertising rules 
applicable to advice provided by broker-dealers be enhanced?
     Should broker-dealers who provide investment advice but 
who are excepted from the Investment Advisers Act nonetheless be 
subject to the fiduciary obligations imposed by that Act on investment 
advisers?
     Should obligations under the Investment Advisers Act 
applicable to dually-registered broker-dealers be modified or 
streamlined in order to eliminate regulatory overlap and reduce 
regulatory burdens?
     Are there areas in which the Commission, alone or in 
concert with other agencies, can engage in investor education efforts 
to assist investors to better understand the duties and obligations of 
their financial service providers?
    The staff is to provide options and recommendations concerning:
     The scope of the study;
     Appropriate persons, both within and outside of the 
Commission, to be involved in the study; and
     Time frames for providing deliverables to the Commission, 
and for expected action by the Commission and its staff.

VI. Cost-Benefit Analysis

    The Commission is sensitive to the costs and benefits of its rules. 
In the Reproposing Release, we identified possible costs and benefits 
of the requirements that now comprise rule 202(a)(11)-1, and requested 
comment on our analysis.\188\ The analysis and the comments we received 
are discussed below.
---------------------------------------------------------------------------

    \188\ Our 1999 Proposal also analyzed the costs and benefits of 
our first proposal to keep broker-dealers from being subject to the 
Advisers Act solely as a result of re-pricing their full-service 
brokerage services. The comments on our 1999 Proposal have also 
informed our analysis in preparing this cost benefit analysis.
---------------------------------------------------------------------------

A. Fee-Based and Discount Brokerage Accounts

    Under rule 202(a)(11)-1(a)(1), 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 their investment advice is solely incidental to the 
brokerage services provided to the account, and they make certain 
disclosures in their advertising and agreements for such accounts. In 
addition, rule 202(a)(11)-1(a)(2) clarifies 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.
1. Benefits
a. Avoidance of Compliance Costs
    The provisions of rule 202(a)(11)-1(a) are designed to permit 
broker-dealers to offer certain fee-based and discount brokerage 
programs without triggering regulation under the Advisers Act. Broker-
dealers relying on rule 202(a)(11)-1(a) to continue offering these fee-
based and discount brokerage programs will benefit in the form of saved 
costs they would otherwise expend in connection with Advisers Act 
compliance.
    Broker-dealers, even those already dually-registered as investment 
advisers, will benefit in the form of costs saved by not having to 
convert their fee-based and full-service brokerage accounts into 
advisory accounts. For example, these accounts will not be subject to 
brochure delivery or other disclosure requirements under the Advisers 
Act, or to the principal trading restrictions under the Act. Other 
broker-dealers relying on rule 202(a)(11)-1(a) will not be subject to 
the Advisers Act at all. For these broker-dealers whose fee-based or 
discount brokerage programs would otherwise require adviser 
registration, we believe the rule's benefits will be significant in 
terms of avoiding an increased regulatory burden incurred as a result 
of changing the way they charge for their brokerage services. For 
example, if not excepted under rule 202(a)(11)-1(a), these broker-
dealers would be required to prepare, submit and update adviser 
registration statements,\189\ and to prepare and distribute client 
disclosures under Part II of Form ADV.\190\ These broker-dealers would 
also be required to modify their compliance programs to address the 
Advisers Act and its requirements,\191\ and to establish codes

[[Page 20443]]

of ethics required under the Act's rules.\192\
---------------------------------------------------------------------------

    \189\ Advisers registered with the Commission must prepare Part 
1A of Form ADV and file it with the SEC on the IARD system. Since 
Part 1A requires advisers to answer basic questions about their 
businesses, and can be completed using information readily available 
to the registrant, costs to prepare the form are typically small, 
but for some larger registrants with complex operations and many 
employees and affiliates, the costs may be somewhat higher, and may 
include professional fees. Adviser registrants submitting their Form 
ADVs through the IARD are required to pay filing fees to the 
operator of the system which range from $150 to $1,100 initially and 
$100 to $550 annually. See Designation of NASD Regulation, Inc. to 
Establish the Investment Adviser Registration Depository; Approval 
of IARD Fees, Investment Advisers Act Release No. 1888 (July 28, 
2000) [65 FR 47807 (Aug. 3, 2000)].
    \190\ Rule 204-3 [17 CFR 275.204-3].
    \191\ Rule 206(4)-7 [17 CFR 275.206(4)-7].
    \192\ Rule 204A-1 [17 CFR 275.204A-1].
---------------------------------------------------------------------------

    Because the costs of satisfying these and other requirements under 
the Advisers Act vary from firm to firm depending on its size and 
complexity, the benefits to brokers in the form of cost savings are 
difficult to quantify. Broker-dealer firms did not comment directly on 
the extent of these benefits in connection with fee-based or full-
service accounts. However, we note that several broker-dealers 
commented on the costs of applying the Advisers Act in other contexts 
under our Reproposal, and most of these broker-dealers characterized 
the costs as significant.\193\ We also note that the popularity of fee-
based accounts is growing rapidly, so the extent of these benefits will 
grow accordingly. One broker-dealer commented that its holdings of fee-
based accounts have tripled since 1999, and one consulting firm 
estimates that assets in fee-based brokerage programs nationwide grew 
by 60.9 percent during 2003 and 2004.\194\
---------------------------------------------------------------------------

    \193\ See infra notes 224-228, 233-237, and accompanying text, 
discussing commenters' assessments of the costs of complying with 
the Advisers Act in connection with financial planning and 
discretionary accounts.
    \194\ Morgan Stanley Letter, supra note 29; Cerulli Edge 1st 
Quarter 2005, supra note 79.
---------------------------------------------------------------------------

    Securities markets will also benefit because the rule would 
preserve the ability of broker-dealers to engage in principal 
transactions with these fee-based brokerage customers.\195\ Principal 
transactions are an important source of liquidity in some market 
sectors.\196\ While one commenter pointed out that the current effect 
on liquidity should be minor because fee-based accounts make up a small 
percentage of the overall securities markets,\197\ continuing growth in 
fee-based accounts could, absent rule 202(a)(11)-1, eventually extend 
principal trading restrictions to many brokerage accounts, thereby 
expanding the effects.\198\ Another commenter suggested the Commission 
could moderate the effects of principal transaction restrictions by 
creating exceptions as necessary to maintain market efficiency.\199\
---------------------------------------------------------------------------

    \195\ Section 206(3) of the Advisers Act prohibits an adviser, 
acting as principal for its own account, from knowingly selling any 
security to or purchasing any security from a client, without 
disclosing to the client in writing the capacity in which it (or an 
affiliate) is acting and obtaining the client's consent before the 
completion of the transaction. Notification and consent must be 
obtained separately for each transaction, i.e., blanket consent for 
transactions is not permitted. Investment Advisers Act Release No. 
40 (Jan. 5, 1945). Section 206(3) also prohibits an adviser from 
acting as broker for both its advisory client and the party on the 
other side of the brokerage transaction without obtaining its 
client's consent before each transaction. The SEC has adopted a rule 
permitting these ''agency cross-transactions'' without transaction-
by-transaction disclosure if the client has given blanket consent in 
writing and certain other conditions are met, but the adviser must 
still act in the best interests of their clients, including the duty 
to obtain best price and execution for any transaction. Rule 206(3)-
2 [17 C.F.R. 275.206(3)-2].
    \196\ See Merrill Lynch Letter, supra note 29; Morgan Stanley 
Letter, supra note 29; UBS Letter, supra note 29.
    \197\ FPA Letter, supra note 27. The FPA's analysis focuses on 
the $3.9 trillion of securities currently held by individual 
investors (since the remainder of the $15 trillion in total 
securities currently in the market are held by institutional 
investors and public companies that are unlikely to pay asset-based 
brokerage fees). The currently-estimated $250-$260 billion of assets 
held in fee-based accounts represents only 6.4% of the $3.9 trillion 
held by individual investors.
    \198\ See supra note 82 and accompanying text.
    \199\ 199 D.C. Securities Bureau Letter, supra Federal Register 
note 112.
---------------------------------------------------------------------------

b. Investor Benefits
    By eliminating regulatory disincentives to re-pricing of brokerage 
services, rule 202(a)(11)-1(a) is expected to yield benefits for 
individual investors as a result of such re-pricing. Under the fee-
based programs discussed above, a broker-dealer's compensation does not 
depend on the number of transactions or the size of mark-ups or mark-
downs charged, thus reducing incentives for the broker-dealer to churn 
accounts, recommend unsuitable securities, or engage in high-pressure 
sales tactics. As such, these programs may better align the interests 
of broker-dealers and their customers. The rule will also benefit 
customers by enabling them to choose from among these new programs and 
other traditional brokerage services to select the program best for 
them.\200\ While it is difficult to quantify the value of these 
benefits, we believe they are substantial. One broker-dealer estimates 
that, during the last five years, its fee-based account customers would 
have paid nearly $2 billion more using commission-based brokerage 
instead of their fee-based accounts.\201\
---------------------------------------------------------------------------

    \200\ SROs can also ensure that sales practices requirements 
address any investor protection concerns. For example, the NASD has 
issued a Notice to Members requiring supervisory procedures to 
determine whether fee-based brokerage is appropriate for a customer 
and periodic review of the customer's accounts to determine whether 
it continues to be appropriate. See NASD Notice to Members 03-68, 
supra note 95.
    \201\ Morgan Stanley Letter, supra note 29 (estimating 
commission savings for all fee-based accounts opened at the broker-
dealer from 2000-2004).
---------------------------------------------------------------------------

2. Costs
    While we believe the benefits of rule 202(a)(11)-1(a) are 
substantial, we believe the incremental costs associated with this 
provision of the rule are small. The only incremental cost associated 
with this provision of the rule will be the cost of making the 
disclosure required by the rule. Broker-dealers relying on the rule's 
exception will be required to add a prominent disclosure statement to 
customer communications for accounts covered by the rule's exception. 
The disclosure consists of a brief plain-English statement that 
indicates the account is a brokerage account, not an advisory account, 
and encourages the customer to ask questions and gain an understanding 
of his or her rights and the broker-dealer's obligations, including the 
broker-dealer's obligations to disclose conflicts of interest. The 
disclosure also discusses compensation issues, including the fact that 
the firm's profits and salespersons' compensation may depend on what 
the customer buys and may include compensation from other persons. The 
disclosure statement must also direct the customers to a contact person 
who can discuss with the customers the differences between brokerage 
and advisory accounts.
    The cost of disclosure would be incurred only by those broker-
dealers electing to rely on the rule, and as we discuss in our 
Paperwork Reduction Act analysis, we believe the cost of the disclosure 
is insignificant.\202\ In addition, we estimate that the total 
industry-wide costs for contact persons at broker-dealers to respond to 
customer questions about their fee-based accounts will be approximately 
$3.2 million annually.\203\
---------------------------------------------------------------------------

    \202\ See Section VIII of this Release, infra. We estimate that 
a compliance manager at a broker-dealer relying on the rule would, 
in connection with reviewing the firm's new contracts, agreements 
and other forms (and advertising, if any), spend an additional five 
minutes each year verifying that the brief disclosure statement is 
included. At an estimated hourly compensation rate for a compliance 
manager of $45, this is $3.75 per firm relying on the exception. See 
Securities Industry Association, Report on Management & Professional 
Earnings in the Securities Industry 2003 (Sept. 2003) (average 
salary for a compliance manager (New York City) is $66,667, to which 
we have added 35% for benefits and overhead). In addition, based on 
information submitted by broker-dealers on Form BD as of December 
15, 2004, approximately 40 percent of all broker-dealers engage 
exclusively in specialized types of broker-dealer activities that 
are extremely unlikely to involve fee-based customer accounts, and 
approximately 3,850 engage in types of broker-dealer activities that 
might potentially include offering fee-based accounts. Thus, the 
industry-wide cost of the disclosure statement is $3.75 per firm x 
3,850 firms = $14,437.50.
    \203\ This estimate is premised on next year's growth of fee-
based accounts continuing at current annual growth rates of 
approximately 30 percent, which would add approximately $80 billion 
to the current base of $268 billion in fee-based accounts. Based on 
an average size for a fee-based account of $211,600 (our staff's 
estimate based on examination observations), this equates to 
approximately 378,000 new accounts. This estimate is also premised 
on 75 percent of these new fee-based account customers contacting 
their broker-dealer and the contact person spending an average of 15 
minutes to respond to their questions, for a total of 70,875 hours. 
At an estimated hourly wage rate for a compliance manager of $45, 
the estimated industry-wide cost is 70,875 x $45 = $3,189,375. See 
supra note 202.

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[[Page 20444]]

    One broker-dealer expressed concern about the cost of litigation 
that might arise challenging the adequacy of contact persons' 
discussion of the differences between accounts, particularly in large 
firms where it may be necessary to make a number of contact persons 
available.\204\ However, broker-dealers have typically encountered 
similar risks in connection with their operations, and can address 
these risks through usual measures such as written procedures and 
personnel training, followed up as necessary with compliance oversight. 
We recognize that large broker-dealers will incur certain costs to 
implement these controls, but we do not believe they are burdensome, 
and commenters generally did not suggest they would be. One large 
broker-dealer commented that disclosure of the differences between fee-
based accounts and advisory accounts is consistent with its existing 
practice, and supported the contact person requirement as preferable to 
formulating long and detailed written explanations of the differences 
between accounts.\205\
---------------------------------------------------------------------------

    \204\ Wachovia Letter, supra note 29.
    \205\ UBS Letter, supra note 29.
---------------------------------------------------------------------------

    Because it would only operate to except from the Advisers Act 
certain brokerage accounts, rule 202(a)(11)-1(a) will not increase the 
regulatory burden borne by investment advisers. Some commenters argued 
the proposed exception would grant broker-dealers--who give investment 
advice without complying with the Advisers Act--a competitive advantage 
over investment advisers subject to the Advisers Act, thereby 
indirectly imposing costs on investment advisers.\206\ However, because 
the rule is restricted to investment advice which is solely incidental 
to brokerage services (and broker-dealers have long been subject to 
this solely incidental standard under section 202(a)(11)(C) of the 
Advisers Act), the rule does not establish new opportunities for 
broker-dealers to compete with advisers on the nature of their 
investment advice.\207\ Also, in providing this advice, broker-dealers 
would remain subject to their own costs of regulation under the 
Exchange Act.\208\ One broker-dealer characterized these costs of 
regulation under the Exchange Act as being so significant that the 
competitive advantage instead lies with advisers regulated under the 
Advisers Act.\209\
---------------------------------------------------------------------------

    \206\ Some commenters argued the rule does competitive harm to 
financial planners in particular. These commenters expressed 
concerns that many broker-dealers market advice that is confusingly 
similar to financial planning, even though it is not the same 
comprehensive advice prepared under a financial plan by persons such 
as Certified Financial Planners (CFPs) acting under CFP professional 
standards. According to these commenters, brokers operating under 
suitability standards are able to provide this advice more 
efficiently than CFPs acting under their professional standards, 
often giving it to customers at no cost, and this erodes the value 
of financial planning and the emerging financial planning industry 
in the minds of the investing public. See, e.g., FPA Letter, supra 
note 27; Comment Letter of David W. Demming (Jan. 16, 2005) 
(``Demming Letter''). On the other hand, several broker-dealers 
commented that they make higher-level comprehensive financial plans 
available for an additional fee, treating customers that elect this 
option as advisory clients. See, e.g., Merrill Lynch Letter, supra 
note 29; Morgan Stanley Letter, supra note 29; UBS Letter, supra 
note 29. Other broker-dealers also commented that many of their 
registered representatives are CFPs. See, e.g., Northwestern Mutual 
Letter, supra note 29. We note that in focus groups of investors we 
convened recently, investors generally understood financial planners 
to have a wider scope of responsibilities for planning, to assist an 
investor in meeting longer-term goals and to address other issues 
such as insurance and estate planning. Some investors also believed 
financial planners would ordinarily have special credentials. Focus 
Group Report, supra note 118, at 9, 13.
    \207\ See supra notes 87-90 and accompanying text.
    \208\ See supra notes 94 and 98 and accompanying text.
    \209\ Comment Letter of Sennet Kirk (Feb. 4, 2005). In addition, 
one broker-dealer expressed concerns that financial planners not, in 
effect, be granted the exclusive right to offer planning services, 
thereby placing broker-dealers at a competitive disadvantage. UBS 
Letter, supra note 29.
---------------------------------------------------------------------------

    Some commenters additionally asserted rule 202(a)(11)-1(a) will 
impose costs on investors, who would not receive the same treatment 
afforded a client of an investment adviser under the Advisers Act.\210\ 
While these commenters argued that the fiduciary duties of an adviser 
outweigh the duties of a broker-dealer, their comments do not fully 
recognize the extent of broker-dealers' obligations.\211\ In addition, 
rule 202(a)(11)-1(a)'s disclosure requirements will put investors on 
notice that there are differences between fee-based brokerage accounts 
and advisory accounts, and provide them with a contact person who can 
answer any questions they may have about the investor protections they 
will receive in their particular circumstances.
---------------------------------------------------------------------------

    \210\ See, e.g., Comment Letter of Bayard Bigelow (Jan. 4, 
2005), whose experience in connection with underwriting errors and 
omissions (``E&O'') insurance policies for broker-dealers and 
investment advisers leads him to infer that the standards of conduct 
for investment advisers result in better investor protection. Mr. 
Bigelow commented that E&O insurance claims against broker-dealers 
were twice as frequent and twice as severe as comparable claims 
against investment advisers.
    \211\ As we discuss supra in notes 94 and 98, and accompanying 
text, broker-dealers are subject to their own obligations to 
disclose conflicts, and are subject to an extensive investor 
protection regime.
---------------------------------------------------------------------------

    Some commenters asserted that the proposed disclosure statement 
would be insufficient to dispel customer confusion about the 
differences between brokerage accounts and advisory accounts, citing 
surveys in which the majority of respondents believed that financial 
advice was a significant component of brokerage services and that 
broker-dealers are obligated to act in investors' best interests.\212\ 
Most respondents in these surveys also indicated their choice between a 
stockbroker and an investment adviser would be affected by the level of 
investor protection available from each.\213\ As discussed above, our 
participants in our investor focus groups found that the disclosure 
statement, as reproposed, alerted them to the fact that differences 
existed between brokerage accounts and advisory accounts. While the 
disclosures did not communicate what those distinctions might mean, 
focus group participants viewed terms such as ``rights'' and 
``obligations'' as important terms that would prompt them to ask 
questions, and they viewed the ability to contact a person at the 
broker-dealer as a positive factor.\214\ In

[[Page 20445]]

addition, other commenters argued that it would be unworkable to expand 
the disclosures to give additional detail about potential differences, 
since the duties of a broker-dealer are determined by, in large part, a 
customer's agreement with the broker-dealer and the circumstances of 
the relationship.\215\
---------------------------------------------------------------------------

    \212\ See Joint Letter of Fund Democracy et al., supra note 28 
(citing a survey prepared for the Consumer Federation of America and 
the Zero Alpha Group) (``CFA Survey'') (available at http://www.zeroalphagroup.com/news/RIvestmentZAG_CFAFINAL_102704.ppt); TD 
Waterhouse Letter, supra note 113 (citing a survey conducted at the 
request of TD Waterhouse USA) (``TD Waterhouse Survey''). According 
to the CFA Survey, 53 percent of respondents indicated the primary 
service of stockbrokers is to offer financial advice, and 25 percent 
indicated advice and assistance in conducting transactions are 
equally important. According to the TD Waterhouse Survey, 58 percent 
of respondents believed stockbrokers and investment advisers both 
have a fiduciary responsibility to act in investors' best interests.
    \213\ In the TD Waterhouse Survey, 86 percent of respondents 
indicated it would impact their choice of financial professional if 
they understood the different levels of investor protection they 
might receive from stockbrokers and investment advisers. In the CFA 
Survey, 36 percent of respondents indicated they would be much less 
likely to use a stockbroker if subject to weaker investor protection 
rules than a financial planner, and 28 percent said they would be 
somewhat less likely. Nearly all respondents in both surveys favored 
identical investor protection rules for stockbrokers and investment 
advisers providing financial advice (90 percent in TD Waterhouse 
Survey; 91 percent in CFA Survey).
    \214\ See Focus Group Report, supra note 118. Participants in 
our focus groups generally indicated that the title of a financial 
services professional was not helpful in inferring what kind of 
investor protection would apply. Id. at 8 & 13. Nevertheless, they 
generally indicated that brokers executed trades and were more 
likely focused on providing advice on specific stocks. Id. at 2-3. 
Our focus groups differed in methodology from the CFA Survey and the 
TD Waterhouse Survey. One potentially significant difference is the 
participants to whom questions were put. The focus group 
participants all managed their investments primarily through a 
broker or investment adviser. While the surveys covered larger 
groups of respondents, the surveys did not assess whether the 
respondents had any experience with broker-dealers or investment 
advisers. The surveys did not exclude investors who, for example, 
held only mutual funds acquired directly from the fund complex (or 
in the case of the CFA Survey, who acquired them through an 
employer-sponsored 401(k) plan), acquired fund investments directly 
from a state 529 plan, or acquired Treasury securities through 
Treasury Direct.
    \215\ SIA Letter, supra note 29; Northwestern Mutual Letter, 
supra note 29. In addition, our focus group participants generally 
indicated that they were confused by the use of legal terms in the 
disclosure, such as ''fiduciary,'' ''rights,'' and ''obligations.''
---------------------------------------------------------------------------

    One commenter urging withdrawal of the rule also encouraged us to 
assess the costs to investors that could arise if broker-dealers engage 
in abusive sales practices in fee-based accounts.\216\ While fee-based 
brokerage accounts are not suitable for all broker-dealer customers, 
the NASD has issued a notice to members identifying potential problems 
and indicating that NASD members should have supervisory procedures in 
place to assess and monitor them.\217\ Given that there are no forms of 
broker-dealer compensation that are immune to potential abuse, it is 
necessary to eliminate the costs of such abuse directly through 
preventative measures and remedial action against abusive market 
participants, rather than indirectly by banning a particular form of 
compensation. Importantly, the direct approach allows investors whose 
accounts are appropriate for fee-based treatment to obtain the benefits 
of it.
---------------------------------------------------------------------------

    \216\ FPA Letter, supra note 27.
    \217\ See supra note 95 and accompanying text.
---------------------------------------------------------------------------

B. Advice That Is Not Solely Incidental to Brokerage

    Rule 202(a)(11)-(b) identifies three circumstances in which the 
provision of advisory services by a broker-dealer is not solely 
incidental to brokerage, making the broker-dealer ineligible for the 
exception from the definition of an investment adviser in section 
202(a)(11)(C) of the Advisers Act, and making such advisory services 
ineligible for the fee-based account exception under rule 202(a)(11)-
1(a). First, a broker-dealer that charges a separate fee or separately 
contracts with a customer for investment advisory services may not rely 
on the exception in the statute or the rule. Second, a broker-dealer 
that holds itself out generally to the public as a financial planner or 
as providing financial planning services must generally register as an 
investment adviser under the Act, and a broker-dealer that delivers a 
financial plan to a customer or represents to a customer that its 
advice is part of a financial plan or in connection with financial 
planning services must also generally register under the Act and treat 
that customer as an advisory client. Third, a broker-dealer may not 
rely on the exceptions for any accounts over which it exercises 
investment discretion.
1. Separate Advisory Services
a. Benefits
    Under rule 202(a)(11)-1(b), brokers that enter into separate 
contracts for, or obtain separate compensation to provide, advisory 
services to an account will be subject to the Advisers Act with respect 
to those accounts. This provision will benefit broker-dealers by 
creating greater transparency with regard to whether particular 
customer relationships are subject to the Advisers Act. As discussed 
above, a separate contract or fee reflects the recognition that the 
advisory services are independent of other brokerage services being 
provided to the investor.\218\ By clarifying that such separate 
services are advisory services, the rule will provide certainty for 
broker-dealers as to whether the Advisers Act applies to their 
activities.
---------------------------------------------------------------------------

    \218\ See supra note 144 and accompanying text.
---------------------------------------------------------------------------

b. Costs
    Broker-dealers entering into separate contracts for, or obtaining 
separate compensation to provide, advisory services will incur 
compliance costs under the Advisers Act with respect to the affected 
accounts. Commenters on the Reproposing Release confirmed, however, 
that broker-dealers generally treat these kinds of arrangements as 
advisory activities subject to the Act.\219\ Accordingly, we believe 
few broker-dealers will incur new compliance costs in connection with 
this aspect of rule 202(a)(11)-1(b).
---------------------------------------------------------------------------

    \219\ Typically, in these arrangements, the broker-dealer is 
charging a separate fee for comprehensive financial planning. See 
SIA Letter, supra note 29; Merrill Lynch Letter, supra note 29; 
Morgan Stanley Letter, supra note 29; UBS Letter, supra note 29.
---------------------------------------------------------------------------

    For the remaining broker-dealers that may currently be entering 
into these arrangements without treating them as advisory activities 
under the Act, compliance costs will be lower if they are dually-
registered broker-dealers that have already established a compliance 
infrastructure under the Advisers Act (or that could shift affected 
accounts to an affiliated investment adviser), and will be higher for 
broker-dealers that will have to become newly-registered under the 
Advisers Act, as discussed below. Because these costs of compliance and 
registration will vary from firm to firm depending on its size and 
complexity, these costs are difficult to quantify: \220\
---------------------------------------------------------------------------

    \220\ While several commenters argued in favor of a rule 
requiring separately-contracted-for advisory services to be subject 
to the Advisers Act (see supra note 145), no commenters supplied 
data on the costs of compliance with this approach.
---------------------------------------------------------------------------

     Affected broker-dealers that are already dually-registered 
as investment advisers will incur the costs of handling these accounts 
through their existing Advisers Act infrastructure. For example, under 
the Advisers Act, they will be required to deliver brochures and make 
other required disclosures with respect to these accounts, and comply 
with principal trading restrictions. Nonetheless, we believe these 
costs will be mitigated because, as registered advisers, these broker-
dealers already have systems in place to satisfy such requirements, and 
the costs are account-specific. Dually-registered broker dealers 
shifting these accounts over to their Advisers Act infrastructure may 
also incur additional documentation costs to execute new account 
agreements with affected clients.
     Other affected broker-dealers may not be dually-
registered, but may be affiliated with investment advisers. These 
broker-dealers could implement the requirements of the rule by shifting 
the advisory activities to their advisory affiliates. In so doing, they 
will incur the lesser compliance costs similar to dual registrants, 
rather than the greater costs discussed below for new registrants.
     For affected broker-dealers that will be required to 
register as investment advisers for the first time, the rule will 
result in costs associated with registration under the Advisers Act and 
compliance with the Act's requirements. Although we acknowledge that 
the costs of registration and compliance under the Advisers Act are 
significant,\221\ we believe that such costs will be mitigated by the 
fact that these firms can build upon the infrastructure they already 
have in place as broker-dealers, much of which overlaps with Advisers 
Act

[[Page 20446]]

requirements. For example, these broker-dealers are already subject to 
rules requiring designation of a chief compliance officer, 
establishment and maintenance of written compliance procedures, 
maintenance of books and records, and oversight of employee personal 
securities trading.\222\ These broker-dealers will ordinarily also be 
in compliance with the adviser custody rule.\223\
---------------------------------------------------------------------------

    \221\ As discussed above in Section VI.A.1.a of this Release, 
these costs include preparing and submitting Part 1 of Form ADV, the 
adviser registration form; preparing and distributing client 
disclosures under Part II of Form ADV; modifying their compliance 
programs to address the Advisers Act and its requirements, and 
establishing adviser codes of ethics.
    \222\ See, e.g., NASD Conduct Rule 3013 (chief compliance 
officer); NASD Conduct Rule 3010(b) (compliance procedures); NASD 
Conduct Rule 3050 (personal trading); NASD Conduct Rule 3110 (books 
and records). See also Exchange Act rule 17a-3 [17 CFR 240.17a-3] 
(records to be maintained by brokers and dealers); Exchange Act rule 
17a-4 [17 CFR 240.17a-4] (records to be preserved by brokers and 
dealers); Exchange Act rule 17a-7 [17 CFR 240.17a-7] (records of 
non-resident brokers and dealers); New York Stock Exchange Rule 342 
(personal trading).
    \223\ Rule 206(4)-2. See Custody of Funds or Securities of 
Clients by Investment Advisers, Investment Advisers Act Rel. No. 
2176 (Sept. 25, 2003) [68 F.R. 56692 (Oct. 1, 2003)] at n.23 and 
n.49, and accompanying text.
---------------------------------------------------------------------------

2. Holding Out as a Financial Planner
a. Benefits
    As a consequence of rule 202(a)(11)-1(b), a broker-dealer that 
holds itself out generally to the public as a financial planner or as 
providing financial planning services must generally register as an 
investment adviser under the Act, and a broker-dealer that delivers a 
financial plan to a customer or represents to a customer that its 
advice is part of a financial plan or in connection with financial 
planning services must also generally register under the Act and treat 
that customer as an advisory client. Rule 202(a)(11)-1(b) will benefit 
these customers by making these services subject to the protections of 
the Advisers Act.
b. Costs
    Broker-dealers that deliver financial plans or make representations 
to customers causing their firms to fall within the provisions of rule 
202(a)(11)-1(b) will incur costs to provide that investment advice to 
those customers in compliance with the Advisers Act. Commenters' 
descriptions of current industry practices lead us to believe this 
aspect of rule 202(a)(11)-1(b) will impose new costs on relatively few 
broker-dealers. Several commenters indicated it is existing practice in 
the brokerage industry to use a two-tiered approach to financial 
planning activities. In the first tier, broker-dealers use certain 
tools (often questionnaires) to analyze customer financial situations 
as an aid to meeting the broker-dealers' suitability obligations, and 
broker-dealers also provide full-service brokerage customers with basic 
financial assessment tools (often computer-assisted evaluations) as an 
integral part of the brokerage process.\224\ In the second tier, 
broker-dealers offer comprehensive financial plans as a separate 
option, for a separate fee, and treat this second-tier service as an 
advisory activity subject to the Act.\225\ So long as broker-dealers 
treat the first-tier activities as an integral part of the brokerage 
account relationship, and do not represent these activities to be 
financial plans, financial planning, or financial planning services, 
they will not be obligated to treat these first-tier activities as 
advisory services under the Advisers Act.
---------------------------------------------------------------------------

    \224\ See The Consortium Letter, supra note 114; Morgan Stanley 
Letter, supra note 29; Merrill Lynch Letter, supra note 29; UBS 
Letter, supra note 29.
    \225\ Id.
---------------------------------------------------------------------------

    Broker-dealers whose operations vary from these industry practices 
will face increased costs as a result of rule 202(a)(11)-1(b), in the 
form of costs to comply with the Advisers Act. Similar to the costs 
discussed above in connection with separately-contracted-for advisory 
services (in Section VI.B.1.b of this Release, above), these compliance 
costs will be lower for dually-registered broker-dealers that have 
already established a compliance infrastructure under the Advisers Act 
(or that could shift affected accounts to an affiliated investment 
adviser), and will be higher for broker-dealers that will have to 
become newly-registered under the Advisers Act, as discussed below. 
Most commenters addressing the costs of treating financial planning 
activities as an advisory activity under the Act characterized the 
costs as significant,\226\ while other commenters indicated they were 
not significant.\227\ Because these costs of compliance and 
registration will vary from firm to firm depending on its size and 
complexity, these costs are difficult to quantify: \228\
---------------------------------------------------------------------------

    \226\ Morgan Stanley Letter, supra note 29; Letter of Steven K. 
McGinnis (Feb. 14, 2005); Demming Letter, supra note 206; Letter of 
Paul E. Coan (Jan. 11, 2005); Letter of Joseph F. Fessler (Jan. 18, 
2005).
    \227\ Comment Letter of Donald S. Loveless (Jan. 20, 2005); 
Comment Letter of Nicholas B. Rowe (Jan. 17, 2005).
    \228\ Commenters did not supply any data concerning these costs.
---------------------------------------------------------------------------

     To the extent that dually-registered broker-dealers will 
be required to treat financial planning activities as advisory 
activities, they will incur costs associated with subjecting such 
activities to the Advisers Act and its requirements (similar to the 
costs to dual registrants of separately-contracted-for advisory 
services, as discussed in Section VI.B.1.b of this Release, above). For 
example, under the Advisers Act, they will be required to deliver 
brochures and make other required disclosures with respect to financial 
planning clients, and comply with principal trading restrictions. 
Nonetheless, we believe these costs will be mitigated because as 
advisers, these broker-dealers already have systems in place to satisfy 
such requirements, and the costs are account-specific. These dually-
registered broker-dealers may also incur additional documentation costs 
to execute new account agreements with financial planning clients.
     Other affected broker-dealers may not be dually-
registered, but may be affiliated with investment advisers. These 
broker-dealers could implement the requirements of the rule by shifting 
the financial planning activities to their advisory affiliates. In so 
doing, they will incur the lesser compliance costs similar to dual 
registrants, rather than the greater costs discussed below for new 
registrants.
     For broker-dealers whose financial planning activities 
will require them to register as investment advisers for the first 
time, the rule will result in costs associated with registration under 
the Advisers Act and compliance with the Act's requirements.\229\ 
Although we acknowledge (as discussed above in connection with 
separately-contracted-for advisory services) that the costs of 
registration and compliance under the Advisers Act are 
significant,\230\ we believe that such costs will be mitigated by the 
fact that these firms can build upon the infrastructure they already 
have in place as broker-dealers, much of which overlaps with Advisers 
Act requirements. For example, these broker-dealers are already subject 
to rules requiring designation of a chief compliance officer, 
establishment and maintenance of written compliance procedures, 
maintenance of books and records, and oversight of employee personal 
securities trading.\231\ These

[[Page 20447]]

broker-dealers will ordinarily also be in compliance with the adviser 
custody rule.\232\
---------------------------------------------------------------------------

    \229\ In the Reproposing Release, we estimated that 
approximately 100 broker-dealers will be required to register under 
the Advisers Act as a consequence of holding themselves out as 
financial planners. See Reproposing Release, supra note 6, at n. 
149-151 and accompanying text. We received no comments on this 
estimate, and since we issued the Reproposing Release, we have 
encountered no other information that would cause us to re-evaluate 
this estimate, or the estimates we discuss in notes 239 and 240, 
infra.
    \230\ See supra note 221.
    \231\ See supra note 222. In addition, we expect these firms 
that will be required to register are likely to be smaller firms; 
larger firms are more likely to be dually-registered already or to 
be affiliated with registered investment advisers to which they can 
shift accounts, as discussed above. These smaller firms' costs to 
comply with the Advisers Act should be further mitigated by the fact 
that their operations are unlikely to be complex or widespread.
    \232\ See supra note 223.
---------------------------------------------------------------------------

3. Discretionary Brokerage
a. Benefits
    Rule 202(a)(11)-1(b) also requires broker-dealers to treat 
discretionary brokerage accounts as advisory accounts under the 
Advisers Act. The rule will benefit investors to the extent they are 
confused as to the nature of discretionary brokerage. As previously 
noted, in many respects discretionary brokerage relationships are 
difficult to distinguish from investment advisory relationships. By 
definitively treating such accounts as advisory accounts, the rule will 
promote understanding by investors of the nature of the service they 
are receiving. More importantly, we believe that it will ensure that 
accounts that have the supervisory or managerial character we have 
identified as warranting Advisers Act coverage are, in fact, covered.
b. Costs
    Rule 202(a)(11)-1(b) will entail costs for broker-dealers that 
maintain discretionary accounts, in the form of Advisers Act compliance 
costs for these accounts. Similar to the costs discussed above in 
connection with separately-contracted-for advisory services and 
financial planning services (in Sections VI.B.1.b and VI.B.2.b of this 
Release, above), these costs will be lower for dually-registered 
broker-dealers that have already established a compliance 
infrastructure under the Advisers Act (or that can shift affected 
accounts to an affiliated investment adviser), and will be higher for 
broker-dealers that will be required to register under the Advisers 
Act.\233\ Commenters addressing the costs of treating discretionary 
accounts as advisory accounts under the Act characterized the costs as 
significant.\234\ Because these costs of compliance and registration 
vary from firm to firm depending on its size and complexity, these 
costs are difficult to quantify: \235\
---------------------------------------------------------------------------

    \233\ Some broker-dealers have limited their acceptance of 
discretionary accounts in accordance with our staff's view that only 
broker-dealers who hold a limited number of such accounts, as 
opposed to those whose accounts are almost exclusively 
discretionary, can avoid being deemed an investment adviser. To the 
extent that broker-dealers have done so, there would be a 
correspondingly limited amount of account-specific costs for broker-
dealers in complying with rule 202(a)(11)-1(b). However, one 
commenter indicated that the majority of accounts at his broker-
dealer were discretionary accounts. Comment Letter of Arthur S. 
Pesner (Feb. 3, 2005) (``Pesner Letter'').
    \234\ SIA Letter, supra note 29; Merrill Lynch Letter, supra 
note 29; Pesner Letter, supra note 233.
    \235\ Commenters did not supply any data concerning these costs.
---------------------------------------------------------------------------

     For broker-dealers already dually-registered as investment 
advisers, rule 202(a)(11)-1(b) will result in costs to treat 
discretionary accounts as advisory accounts. Based on staff experience, 
we believe that many dual registrants currently treat discretionary 
accounts as advisory accounts, and will be in compliance with the new 
rule without further action. To the extent that other dually-registered 
broker-dealers will be required to treat discretionary accounts as 
advisory accounts, they will incur costs associated with subjecting 
such accounts to the Advisers Act and its requirements (similar to the 
costs to dual registrants of separately-contracted-for advisory 
services and financial planning services, as discussed in Sections 
VI.B.1.b and VI.B.2.b of this Release, above). For example, under the 
Advisers Act, they will be required to deliver brochures and make other 
required disclosures with respect to these accounts, and observe 
principal trading restrictions.\236\ Nonetheless, we believe these 
costs would be mitigated because as advisers, these broker-dealers 
already have systems in place to satisfy such requirements, and the 
costs are account-specific. Several commenters focused specifically on 
principal trading restrictions, urging that such restrictions would be 
particularly inconsistent with current practices of certain fixed 
income institutional investors, who grant broker-dealers discretion in 
view of the firm's ability to effect trades on a principal basis.\237\ 
However, we believe the exceptions we discuss above for limited 
discretion will accommodate these investors, if they wish to grant 
their broker-dealers limited types of discretion focused on obtaining 
the benefits of efficient execution or access to types of securities 
not widely available in the market, as opposed to the kind of 
supervisory or managerial discretionary authority we have concluded is 
properly subject to the Advisers Act.\238\
---------------------------------------------------------------------------

    \236\ One commenter focused on additional recordkeeping 
requirements applicable under Advisers Act rule 204-2 (such as 
retaining copies of any written recommendations to clients). SIA 
Letter, supra note 29. Dually-registered broker dealers converting 
discretionary accounts may also incur additional documentation costs 
to execute new account agreements with clients whose accounts are 
affected by the new rule.
    \237\ These commenters noted that some market sectors, such as 
fixed income, are dominated by principal trading, and applying 
principal transaction restrictions might negatively affect liquidity 
in these markets. They also expressed concerns that the notice 
procedures applicable to principal transactions under the Advisers 
Act might make it impossible for them to obtain best execution for 
these fixed income investors. SIA Letter, supra note 29; Morgan 
Stanley Letter, supra note 29; UBS Letter, supra note 29.
    \238\ See supra notes 178-181 and accompanying text.
---------------------------------------------------------------------------

     In many instances, broker-dealers that are not dually 
registered are affiliated with investment advisers. Based on staff 
experience, we believe that many of these broker-dealers have refrained 
from engaging in the discretionary brokerage business, and have instead 
looked to their advisory affiliates to provide portfolio management to 
investors seeking this kind of service. Other broker-dealers that have 
not refrained from accepting discretionary brokerage services could 
implement the requirements of rule 202(a)(11)-1(b) by shifting these 
customers to their advisory affiliates.\239\ In so doing, they will 
incur the lesser compliance costs of the types discussed above for dual 
registrants, rather than the greater costs discussed below for new 
registrants.
---------------------------------------------------------------------------

    \239\ In the Reproposing Release, we estimated that there are 
only 145-290 broker-dealers (approximately) that are not dually-
registered as investment advisers and accept discretionary accounts. 
We estimated that approximately one-third of this group will 
transfer their discretionary accounts to their advisory affiliates. 
(We also estimated approximately one-fifth of this group will be 
able to reach agreements with their customers that allow the firms 
to operate their accounts on a non-discretionary basis.) See 
Reproposing Release, supra note 6, at n. 139-142 and accompanying 
text. We received no comments on these estimates.
---------------------------------------------------------------------------

     For broker-dealers whose maintenance of discretionary 
accounts will require them to register as investment advisers for the 
first time, rule 202(a)(11)-1(b) will result in costs associated with 
registration under the Advisers Act and compliance with the Act's 
requirements.\240\ Although we acknowledge (as discussed above in 
connection with separately-contracted-for advisory services and 
financial planning services in Section VI.B.1.b and VI.B.2.b of this 
Release) that the costs of registration and compliance under the 
Advisers Act are significant,\241\ we believe that such costs will be 
mitigated by the fact that these firms can build upon the 
infrastructure they already have in place as broker-dealers, much of 
which overlaps with Advisers Act requirements. For example, these 
broker-dealers are already subject to rules requiring designation of a 
chief compliance officer, establishment and maintenance

[[Page 20448]]

of written compliance procedures, maintenance of books and records, and 
oversight of employee personal securities trading.\242\ These broker-
dealers will ordinarily also be in compliance with the adviser custody 
rule.\243\
---------------------------------------------------------------------------

    \240\ In the Reproposing Release, we estimated that 
approximately 95 broker-dealers will be required to register under 
the Advisers Act as a consequence of continuing to maintain 
discretionary accounts. See Reproposing Release, supra note 6, at n. 
138-142 and accompanying text. We received no comments on this 
estimate.
    \241\ See supra note 221.
    \242\ See supra note 222. In addition, (similar to the costs for 
broker-dealers engaged in financial planning, supra note 231,) we 
expect these firms that will be required to register are likely to 
be smaller firms; larger firms are more likely to be dually-
registered already or to be affiliated with registered investment 
advisers to which they can shift accounts, as discussed above. These 
smaller firms' costs to comply with the Advisers Act should be 
further mitigated by the fact that their operations are unlikely to 
be complex or widespread.
    \243\ See supra note 223.
---------------------------------------------------------------------------

C. Wrap Fee Sponsorship

    We are re-affirming our current interpretation regarding wrap 
program sponsorship. Since this does not change existing obligations or 
relationships, no new costs or benefits result.

VII. Effects of Competition, Efficiency and Capital Formation

    Section 202(c) of the Advisers Act mandates that the Commission, 
when engaging in rulemaking that requires it to consider or determine 
whether an action is necessary or appropriate in the public interest, 
consider, in addition to the protection of investors, whether the 
action will promote efficiency, competition, and capital 
formation.\244\
---------------------------------------------------------------------------

    \244\ 15 U.S.C. 80b-2(c).
---------------------------------------------------------------------------

A. Fee-Based and Discount Brokerage Programs

    Rule 202(11)(a)-1(a) provides that a broker-dealer providing advice 
that is incidental to its brokerage services can retain its exception 
from the 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 rule also provides that broker-dealers are not subject to 
the Act solely because in addition to offering full-service brokerage 
they offer discount brokerage services, including execution-only 
brokerage, for reduced commission rates.\245\
---------------------------------------------------------------------------

    \245\ Rule 202(a)(11)-1(c) further provides that a registered 
broker-dealer is an investment adviser solely with respect to those 
accounts for which it provides services or receives compensation 
that subjects it to the Advisers Act.
---------------------------------------------------------------------------

    We do not anticipate that rule 202(11)(a)-1(a) will negatively 
affect competition. Many commenters addressing our 1999 Proposal and 
our Reproposing Release raised concerns that the proposed rule would 
grant broker-dealers who give investment advice without registering 
under the Advisers Act a competitive advantage over investment advisers 
subject to the Advisers Act. However, as discussed in Section III.A.1 
of this Release, above, broker-dealers have historically provided 
advisory services to their brokerage customers. As discussed in Section 
III.A.2 of this Release, above, broker-dealers do so subject to the 
cost implications of compliance with broker-dealer regulation. Because 
the rule does not change the types of advice broker-dealers may provide 
(which advice must continue to be solely incidental to brokerage) or 
materially change their compliance costs, we do not anticipate it will 
create a competitive advantage.
    Rule 202(a)(11)-1(a) may increase efficiency by removing 
impediments to fee-based brokerage programs. Fee-based brokerage 
programs, as we discuss above, respond to changes in the market place 
for retail brokerage, and concerns that we have long held about the 
incentives that commission-based compensation provides for broker-
dealers to churn accounts, recommend unsuitable securities, and engage 
in aggressive marketing.\246\ The availability of fee-based brokerage 
programs may better align the interests of broker-dealers and their 
customers. The availability of fee-based and discount brokerage 
programs should also enable brokerage customers to choose these new 
programs when they represent a more efficient alternative than 
commission-based brokerage. One commenter agreed, arguing that pricing 
flexibility generally promotes economic efficiency.\247\
---------------------------------------------------------------------------

    \246\ See supra note 12 and accompanying text.
    \247\ Northwestern Mutual Letter, supra note 29.
---------------------------------------------------------------------------

    If rule 202(a)(11)-1(a) has any effect on capital formation, it 
will be indirect, and positive. By removing impediments to fee-based 
and discount brokerage programs which may be more desirable for 
customers than commission-based programs, rule 202(a)(11)-1(a) may open 
the door to greater investor participation in the securities markets.

B. Discretionary Brokerage and Financial Planning

    Rule 202(a)(11)-(1)(b) specifies three situations in which the 
provision of advisory services by a broker-dealer is not solely 
incidental to brokerage, and such advisory services are thus ineligible 
for the fee-based account exception under rule 202(a)(11)-1(a) or the 
exception from the definition of an investment adviser in section 
202(a)(11)(C) of the Advisers Act. First, a broker-dealer that charges 
a separate fee or separately contracts with a customer for investment 
advisory services may not rely on the exceptions. Second, a broker-
dealer that holds itself out generally to the public as a financial 
planner or as providing financial planning services must generally 
register as an investment adviser under the Act, and a broker-dealer 
that delivers a financial plan to a customer or represents to a 
customer that it is a financial planner or providing a financial plan 
or financial planning services must also generally register under the 
Act and treat that customer as an advisory client. Third, a broker-
dealer may not rely on the exceptions for any accounts over which it 
exercises investment discretion.
    Rule 202(a)(11)-1(b) will not negatively affect competition. Some 
broker-dealers would be required to begin treating as advisory clients 
those customers with whom they make separate contractual or 
compensation arrangements for advisory services, or to whom they 
provide certain financial planning or discretionary account services. 
However, as discussed above, we believe the majority of broker-dealers 
already apply the Advisers Act in the circumstances covered by rule 
202(a)(11)-1(b), so we expect the effects of the rule will not be 
widespread.\248\ As the remaining firms begin applying the Advisers Act 
to these relationships as a result, they will be competing on a more 
even footing with broker-dealers who already do so. We do not believe 
rule 202(a)(11)-1(b) will have any measurable effect on efficiency or 
capital formation.
---------------------------------------------------------------------------

    \248\ See supra Sections VI.B.1.b, VI.B.2.b, and VI.B.3.b of 
this Release.
---------------------------------------------------------------------------

VIII. Paperwork Reduction Act

    Rule 202(a)(11)-1(a) contains ``collection of information'' 
requirements within the meaning of the Paperwork Reduction Act of 
1995.\249\ The title of this new collection is ``Rule 202(a)(11)-1 
under the Investment Advisers Act of 1940--Certain Broker-Dealers 
Deemed Not To Be Investment Advisers,'' and the Commission, at the time 
of its 1999 Proposal, submitted it to the Office of Management and 
Budget (``OMB'') for review in accordance with 44 U.S.C. 3507(d) and 5 
CFR 1320.11. OMB has approved, and subsequently extended, this 
collection under control number 3235-0532 (expiring on October 31, 
2006).
---------------------------------------------------------------------------

    \249\ 44 U.S.C. 3501 to 3520.
---------------------------------------------------------------------------

    Rule 202(a)(11)-1(b) will have the effect of requiring certain 
broker-dealers to register under the Advisers Act.\250\

[[Page 20449]]

Rule 202(a)(11)-1(b) will therefore likely increase the number of 
respondents under several existing collections of information, and, 
correspondingly, increase the annual aggregate burden under those 
existing collections of information. The Commission has submitted to 
OMB, in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11, the 
existing collections of information for which the annual aggregate 
burden would correspondingly increase as a result of rule 202(a)(11)-
1(b). The titles of the affected collections of information are: ``Form 
ADV,'' ``Form ADV-W and Rule 203-2,'' ``Rule 203-3 and Form ADV-H,'' 
``Form ADV-NR,'' ``Rule 204-2,'' ``Rule 204-3,'' ``Rule 204A-1,'' 
``Rule 206(4)-3,'' ``Rule 206(4)-4,'' ``Rule 206(4)-6,'' and ``Rule 
206(4)-7,'' all under the Advisers Act. The existing rules that will be 
affected by rule 202(a)(11)-1(b) contain currently approved collection 
of information numbers under OMB control numbers 3235-0049, 3235-0313, 
3235-0538, 3235-0240, 3235-0278, 3235-0047, 3235-0596, 3253-0242, 3235-
0345, 3235-0571 and 3235-0585, respectively.
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    \250\ Rule 202(a)(11)-1(b) describes three scenarios in which a 
broker-dealer may not rely on the broker-dealer exception from the 
definition of an ``investment adviser'' under the Advisers Act and 
rule 202(a)(11)-1(a). First, a broker-dealer that charges a separate 
fee or separately contracts with a customer for investment advisory 
services may not rely on the exceptions. Second, a broker-dealer 
that holds itself out generally to the public as a financial planner 
or as providing financial planning services may not generally rely 
on the exceptions to avoid registration under the Act, and a broker-
dealer that delivers a financial plan to a customer or represents to 
a customer that its advice is part of a financial plan or in 
connection with financial planning services must also generally 
register under the Act and treat that customer as an advisory 
client. Third, a broker-dealer may not rely on the exceptions for 
any accounts over which it exercises investment discretion. See rule 
202(a)(11)-1(b).
---------------------------------------------------------------------------

    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless it displays a 
currently valid OMB control number.

A. Certain Broker-Dealers Deemed Not To Be Investment Advisers

    Under rule 202(a)(11)-1(a), broker-dealers will be deemed not to be 
``investment advisers'' as defined in the Advisers Act with respect to 
certain accounts. With respect to these accounts, such broker-dealers 
will not be subject to the provisions of the Advisers Act, including 
the various registration, disclosure and recordkeeping requirements 
under the Act. Under rule 202(a)(11)-1(a), a broker-dealer will not be 
deemed to be an investment adviser with respect to an account for which 
it receives special compensation, provided that the broker-dealer's 
investment advice is solely incidental to the brokerage services 
provided to the account and the broker-dealer makes certain disclosures 
in its advertising and agreements for such accounts.
    In the Reproposing Release, we noted that broker-dealers taking 
advantage of the proposed exception would need to maintain certain 
records that establish their eligibility to do so, but that rules under 
the Exchange Act already require the maintenance of those records.\251\ 
Therefore, we concluded that this facet of the proposed exception would 
not increase the recordkeeping burden for any broker-dealer.
---------------------------------------------------------------------------

    \251\ See Reproposing Release, supra note 6, at Section VII. 
Specifically, rule 202(a)(11)-1(a)(i) and rule 202(a)(11)-1(b)(3) 
have the effect of limiting the application of rule 202(a)(11)-1(a) 
to accounts over which a broker-dealer does not exercise investment 
discretion. Rule 202(a)(11)-1(a)(1)(ii) also requires a prominent 
statement be made in agreements governing the accounts to which the 
rule applies. Under Exchange Act rules, broker-dealers are already 
required to maintain all ''evidence of the granting of discretionary 
authority given in any respect of any account'' [17 CFR 240.17a-
4(b)(6)] and all ''written agreements * * * with respect to any 
account'' [17 CFR 240.17a-4(b)(7)].
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    To rely on the rule 202(a)(11)-1(a) with respect to a particular 
brokerage account, advertisements \252\ and contracts or agreements for 
the account must contain a prominent disclosure statement. The 
disclosure consists of a brief plain English statement that indicates 
the account is a brokerage account, not an advisory account, and 
encourages the customer to ask questions and gain an understanding of 
his or her rights and the broker-dealer's obligations, including the 
broker-dealer's obligations to disclose conflicts of interest. The 
disclosure also discusses compensation issues, including the fact that 
the firm's profits and salespersons' compensation may depend on what 
the customer buys and may include compensation from other persons. The 
disclosure statement must also direct the customers to a contact person 
who can discuss with the customers the differences between brokerage 
and advisory accounts.\253\ 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 customers in making an informed decision on whether to 
establish an account. The collection of information requirement under 
rule 202(a)(11)-1(a) is mandatory. In general, the information 
collected pursuant to the rule will be held by the broker-dealers. 
Staff of the Commission, self-regulatory organizations, and other 
securities regulatory authorities would gain access to the information 
only upon request. Any collected information received by the Commission 
will be kept confidential subject to applicable law, including the 
provisions of the Freedom of Information Act [5 U.S.C. 552].
---------------------------------------------------------------------------

    \252\ As discussed in the Reproposing Release, broker-dealers 
already are required to maintain records regarding their 
advertisements under existing self-regulatory organizations' rules.
    \253\ Rule 202(a)(11)-1(a)(1)(ii).
---------------------------------------------------------------------------

    The burden to comply with this provision of rule 202(a)(11)-1(a) 
will be insignificant. In preparing model contracts and advertisements, 
for example, compliance officials will be required to verify that the 
appropriate disclosure is made. In the Reproposing Release, we 
estimated that the average annual burden for ensuring compliance is 
five minutes per broker-dealer taking advantage of the rule.\254\ We 
estimated that if all of the approximately 8,100 broker-dealers 
registered with us took advantage of the rule, the total estimated 
annual burden would be 673 hours.\255\ In our 1999 Proposal, the rule 
only required a prominent statement that the account is a brokerage 
account. In our Reproposing Release, we proposed to add disclosures 
that the account is not an advisory account; that the firm's 
obligations with respect to such accounts may differ; and that, as a 
consequence, the customer's rights and the firm's duties and 
obligations to the customer, including the scope of the firm's 
fiduciary obligations, may differ. We also proposed to require the 
broker-dealer to identify an appropriate person at the firm with whom 
the customer can discuss the differences. The rule today modifies the 
prominent statement slightly to put the prominent disclosure statement 
into plain English, and to discuss broker compensation issues briefly. 
However, these modifications to the disclosure obligations under rule 
202(a)(11)-1(a) do not increase the estimated paperwork burden for this 
collection.
---------------------------------------------------------------------------

    \254\ See Reproposing Release, supra note 6, at Section VII.
    \255\ 0.083 hours x 8,100 broker-dealers = 673 hours.
---------------------------------------------------------------------------

B. Broker-Dealers Providing Discretionary Advice or Financial Plans

    As discussed above, under rule 202(a)(11)-1(b), broker-dealers 
providing advisory services in three scenarios will be deemed advisers 
subject to the Advisers Act.\256\ Rule 202(a)(11)-1(b) will therefore 
increase the number of respondents under the existing collections of 
information identified above, and, correspondingly, increase the annual 
aggregate burden under those existing collections of

[[Page 20450]]

information. All of these collections of information are mandatory, and 
respondents in each case are investment advisers registered with us, 
except that (i) respondents to Form ADV are also investment advisers 
applying for registration with us; (ii) respondents to Form ADV-NR are 
non-resident general partners or managing agents of registered 
advisers; (iii) respondents to rule 204A-1 include ``access persons'' 
of an adviser registered with us, who must submit reports of their 
personal trading to their advisory firms; (iv) respondents to rule 
206(4)-3 are advisers who pay cash fees to persons who solicit clients 
for the adviser; (v) respondents to rule 206(4)-4 are advisers with 
certain disciplinary histories or a financial condition that is 
reasonably likely to affect contractual commitments; and (vi) 
respondents to rule 206(4)-6 are only those SEC-registered advisers 
that vote their clients' securities. Unless otherwise noted below, 
responses are not kept confidential.
---------------------------------------------------------------------------

    \256\ See supra note 250.
---------------------------------------------------------------------------

    We cannot quantify with precision the number of broker-dealers that 
will be new registrants with the Commission under the Advisers Act as a 
result of Rule 202(a)(11)-1(b). In the Reproposing Release, we set out 
our analysis that an estimated 195 broker-dealers would be required to 
register, and requested public comments.\257\ We received no comments 
on this analysis, and have encountered no information since the time of 
the Reproposing Release that would cause us to re-evaluate it. Thus, 
for purposes of this analysis, we have estimated 195 new firms would be 
required to register with the SEC as investment advisers as a result of 
rule 202(a)(11)-1(b).
---------------------------------------------------------------------------

    \257\ See Reproposing Release, supra note 6, at Section VII.
---------------------------------------------------------------------------

1. Form ADV
    Form ADV is the investment adviser registration form. The 
collection of information under Form ADV is necessary to provide 
advisory clients, prospective clients, and the Commission with 
information about the adviser, its business, and its conflicts of 
interest. Rule 203-1 requires every person applying for investment 
adviser registration with the Commission to file Form ADV. Rule 204-1 
requires each SEC-registered adviser to file amendments to Form ADV at 
least annually, and requires advisers to submit electronic filings 
through the IARD. This collection of information is found at 17 CFR 
275.203-1, 275.204-1, and 279.1. The currently approved collection of 
information in Form ADV is 131,611 hours. We estimate that 195 new 
respondents will file one complete Form ADV and one amendment annually, 
and comply with Form ADV requirements relating to delivery of the 
adviser code of ethics. Accordingly, we estimate rule 202(a)(11)-1(b) 
will increase the annual aggregate information collection burden under 
Form ADV by 5,792 hours \258\ for a total of 137,403 hours.
---------------------------------------------------------------------------

    \258\ 195 filings of the complete form at 22.25 hours each, plus 
195 amendments at 0.75 hours each, plus 6.7 hours for each of the 
195 broker-dealer/advisers to deliver copies of their codes of 
ethics to 10 percent of their 670 clients annually who request it, 
at 0.1 hours per response. (195 x 22.25) + (195 x 0.75) + (195 x 
(670 x 0.1) x 0.1) = 5,791.5.
---------------------------------------------------------------------------

2. Form ADV-W and Rule 203-2
    Rule 203-2 requires every person withdrawing from investment 
adviser registration with the Commission to file Form ADV-W. The 
collection of information is necessary to apprise the Commission of 
advisers who are no longer operating as registered advisers. This 
collection of information is found at 17 CFR 275.203-2 and 17 CFR 
279.2. The currently approved collection of information in Form ADV-W 
is 578 hours. We estimate that the 195 broker-dealer/advisers that will 
be new registrants will withdraw from SEC registration at a rate of 
approximately 16 percent per year, the same rate as other registered 
advisers, and will file for partial and full withdrawals at the same 
rates as other registered advisers, with approximately half of the 
filings being full withdrawals and half being partial withdrawals. 
Accordingly, we estimate the rule 202(a)(11)-1(b) will increase the 
annual aggregate information collection burden under Form ADV-W and 
rule 203-2 by 16 hours \259\ for a total of 594 hours.
---------------------------------------------------------------------------

    \259\ 32 filings (195 x 0.16), consisting of 16 full withdrawals 
at 0.75 hours each and 16 partial withdrawals at 0.25 hours each. 
(16 x 0.75) + (16 x 0.25) = 16.
---------------------------------------------------------------------------

3. Rule 203-3 and Form ADV-H
    Rule 203-3 requires that advisers requesting either a temporary or 
continuing hardship exemption submit the request on Form ADV-H. An 
adviser requesting a temporary hardship exemption is required to file 
Form ADV-H, providing a brief explanation of the nature and extent of 
the temporary technical difficulties preventing it from submitting a 
required filing electronically. Form ADV-H requires an adviser 
requesting a continuing hardship exemption to indicate the reasons the 
adviser is unable to submit electronic filings without undue burden and 
expense. Continuing hardship exemptions are available only to advisers 
that are small entities. The collection of information is necessary to 
provide the Commission with information about the basis of the 
adviser's hardship. This collection of information is found at 17 CFR 
275.203-3, and 279.3. The currently approved collection of information 
in Form ADV-H is 11 hours. We estimate that approximately one broker-
dealer/adviser among the new registrants will file for a temporary 
hardship exemption and one will file for a continuing exception. 
Accordingly, we estimate the rule 202(a)(11)-1(b) will increase the 
annual aggregate information collection burden under Form ADV-H and 
rule 203-3 by 2 hours \260\ for a total of 13 hours.
---------------------------------------------------------------------------

    \260\ 2 filings at 1 hour each.
---------------------------------------------------------------------------

4. Form ADV-NR
    Non-resident general partners or managing agents of SEC-registered 
investment advisers must make a one-time filing of Form ADV-NR with the 
Commission. Form ADV-NR requires these non-resident general partners or 
managing agents to furnish us with a written irrevocable consent and 
power of attorney that designates the Secretary of the Commission, 
among others, as an agent for service of process, and that stipulates 
and agrees that any civil suit or action against such person may be 
commenced by service of process on the Secretary of the Commission. The 
collection of information is necessary for us to obtain appropriate 
consent to permit the Commission and other parties to bring actions 
against non-resident partners or agents for violations of the federal 
securities laws. This collection of information is found at 17 CFR 
279.4. The currently approved collection of information in Form ADV-NR 
is 17 hours. We estimate that approximately one broker-dealer/adviser 
among the new registrants will make this filing. Accordingly, we 
estimate the rule 202(a)(11)-1(b) will increase the annual aggregate 
information collection burden under Form ADV-NR by one hour \261\ for a 
total of 18 hours.
---------------------------------------------------------------------------

    \261\ 1 filing at 1 hour each.
---------------------------------------------------------------------------

5. Rule 204-2
    Rule 204-2 requires SEC-registered investment advisers to maintain 
copies of certain books and records relating to their advisory 
business. The collection of information under rule 204-2 is necessary 
for the Commission staff to use in its examination and oversight 
program. Responses provided to the Commission in the context of its 
examination and oversight program are

[[Page 20451]]

generally kept confidential.\262\ The records that an adviser must keep 
in accordance with rule 204-2 must generally be retained for not less 
than five years.\263\ This collection of information is found at 17 CFR 
275.204-2. The currently approved collection of information for rule 
204-2 is 1,724,870 hours, or 191.78 hours per registered adviser. We 
estimate that all 195 broker-dealer/advisers that will be new 
registrants will maintain copies of records under the requirements of 
rule 204-2. Accordingly, we estimate rule 202(a)(11)-1(b) will increase 
the annual aggregate information collection burden under rule 204-2 by 
37,397 hours \264\ for a total of 1,762,267 hours.
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    \262\ See section 210(b) of the Advisers Act [15 U.S.C. 80b-
10(b)].
    \263\ See rule 204-2(e).
    \264\ 195 broker-dealer/advisers x 191.78 hours per adviser = 
37,397 hours.
---------------------------------------------------------------------------

6. Rule 204-3
    Rule 204-3, the ``brochure rule,'' requires an investment adviser 
to deliver to prospective clients a disclosure statement containing 
specified information as to the business practices and background of 
the adviser. Rule 204-3 also requires that an investment adviser 
deliver, or offer, its brochure on an annual basis to existing clients 
in order to provide them with current information about the adviser. 
The collection of information is necessary to assist clients in 
determining whether to retain, or continue employing, the adviser. This 
collection of information is found at 17 CFR 275.204-3. The currently 
approved collection of information for rule 204-3 is 6,089,293 hours, 
or 694 hours per registered adviser, assuming each adviser has on 
average 670 clients.\265\ We estimate that all 195 broker-dealer/
advisers that will be new registrants will provide brochures as 
required by rule 204-3. Accordingly, we estimate rule 202(a)(11)-1(b) 
will increase the annual aggregate information collection burden under 
rule 204-3 by 135,330 hours \266\ for a total of 6,224,623 hours.
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    \265\ We note that the average number of clients per adviser 
reflects a small number of advisers who have thousands of clients, 
while the typical SEC-registered adviser has approximately 76 
clients.
    \266\ 195 broker-dealer/advisers x 694 hours per adviser = 
135,330.
---------------------------------------------------------------------------

7. Rule 204A-1
    Rule 204A-1 requires SEC-registered investment advisers to adopt 
codes of ethics setting forth standards of conduct expected of their 
advisory personnel and addressing conflicts that arise from personal 
securities trading by their personnel, and requiring advisers' ``access 
persons'' to report their personal securities transactions. The 
collection of information under rule 204A-1 is necessary to establish 
standards of business conduct for supervised persons of investment 
advisers and to facilitate investment advisers' efforts to prevent 
fraudulent personal trading by their supervised persons. This 
collection of information is found at 17 CFR 275.204A-1. The currently 
approved collection of information for rule 204A-1 is 1,060,842 hours, 
or 117.95 hours per registered adviser. We estimate that all 195 
broker-dealer/advisers that will be new registrants will adopt codes of 
ethics under the requirements of rule 204A-1 and require personal 
securities transaction reporting by their ``access persons.'' 
Accordingly, we estimate rule 202(a)(11)-1(b) will increase the annual 
aggregate information collection burden under rule 204A-1 by 23,000 
hours \267\ for a total of 1,083,842 hours.
---------------------------------------------------------------------------

    \267\ 195 broker-dealer/advisers x 117.95 hours per adviser 
annually = 23,000.
---------------------------------------------------------------------------

8. Rule 206(4)-3
    Rule 206(4)-3 requires advisers who pay cash fees to persons who 
solicit clients for the adviser to observe certain procedures in 
connection with solicitation activity. The collection of information 
under rule 206(4)-3 is necessary to inform advisory clients about the 
nature of a solicitor's financial interest in the recommendation of an 
investment adviser, so the client may consider the solicitor's 
potential bias, and to protect investors against solicitation 
activities being carried out in a manner inconsistent with the 
adviser's fiduciary duties. This collection of information is found at 
17 CFR 275.206(4)-3. The currently approved collection of information 
for rule 206(4)-3 is 12,355 hours. We estimate that approximately 20 
percent of the 195 broker-dealer/advisers that will be new registrants 
will be subject to the cash solicitation rule, the same rate as other 
registered advisers. Accordingly, we estimate rule 202(a)(11)-1(b) will 
increase the annual aggregate information collection burden under rule 
206(4)-3 by 275 hours \268\ for a total of 12,630 hours.
---------------------------------------------------------------------------

    \268\ 39 respondents (195 x 0.2) x 7.04 hours annually per 
respondent = 275.
---------------------------------------------------------------------------

9. Rule 206(4)-4
    Rule 206(4)-4 requires registered investment advisers to disclose 
to clients and prospective clients certain disciplinary history or a 
financial condition that is reasonably likely to affect contractual 
commitments. This collection of information is necessary for clients 
and prospective clients in choosing an adviser or continuing to employ 
an adviser. This collection of information is found at 17 CFR 
275.206(4)-4. The currently approved collection of information for rule 
206(4)-4 is 11,383 hours. We estimate that approximately 17.3 percent 
of the 195 broker-dealer/advisers that will be new registrants will be 
subject to rule 206(4)-4, the same rate as other registered advisers. 
Accordingly, we estimate rule 202(a)(11)-1(b) will increase the annual 
aggregate information collection burden under rule 206(4)-4 by 255 
hours \269\ for a total of 11,638 hours.
---------------------------------------------------------------------------

    \269\ 34 respondents (195 x 0.173) x 7.5 hours annually per 
respondent = 255.
---------------------------------------------------------------------------

10. Rule 206(4)-6
    Rule 206(4)-6 requires an investment adviser that votes client 
securities to adopt written policies reasonably designed to ensure that 
the adviser votes in the best interests of clients, and requires the 
adviser to disclose to clients information about those policies and 
procedures. This collection of information is necessary to permit 
advisory clients to assess their adviser's voting policies and 
procedures and to monitor the adviser's performance of its voting 
responsibilities. This collection of information is found at 17 CFR 
275.206(4)-6. The currently approved collection of information for rule 
206(4)-6 is 119,873 hours. We estimate that all 195 broker-dealer/
advisers that will be new registrants will vote their clients' 
securities. Accordingly, we estimate rule 202(a)(11)-1(b) will increase 
the annual aggregate information collection burden under rule 206(4)-6 
by 3,257 hours \270\ for a total of 123,130 hours.
---------------------------------------------------------------------------

    \270\ We estimate that 195 broker-dealer/advisers would spend 10 
hours each annually documenting their voting policies and 
procedures, and would provide copies of those policies and 
procedures to 10 percent of their 670 clients annually at 0.1 hours 
per response. (195 x 10) + 195 x (0.1 x 67) = 3,257.
---------------------------------------------------------------------------

11. Rule 206(4)-7
    Rule 206(4)-7 requires each registered investment adviser to adopt 
and implement written policies and procedures reasonably designed to 
prevent violations of the Advisers Act, review those policies and 
procedures annually, and designate an individual to serve as chief 
compliance officer. This collection of information under rule 206(4)-7 
is necessary to ensure that investment advisers maintain comprehensive 
internal programs that promote the advisers' compliance with the 
Advisers Act. This collection of information is found at 17 CFR

[[Page 20452]]

275.206(4)-7. The currently approved collection of information for rule 
206(4)-7 is 701,200 hours, or 80 hours annually per registered adviser. 
We estimate all 195 broker-dealer/advisers that will be new registrants 
will be required to maintain compliance programs under rule 206(4)-7. 
Accordingly, we estimate rule 202(a)(11)-1(b) will increase the annual 
aggregate information collection burden under rule 206(4)-7 by 15,600 
hours \271\ for a total of 716,800 hours.
---------------------------------------------------------------------------

    \271\ 195 broker-dealer/advisers at 80 hours per adviser 
annually = 15,600.
---------------------------------------------------------------------------

IX. Regulatory Flexibility Analysis

    The Commission proposed rule 202(a)(11)-1 and related proposed 
interpretations of section 202(a)(11)(C) of the Advisers Act, in a 
release on January 6, 2005 (``Reproposing Release''). An Initial 
Regulatory Flexibility Analysis (``IRFA'') was published in the 
Reproposing Release. No comments were received specifically on the 
IRFA. The Commission has prepared the following Final Regulatory 
Flexibility Analysis (``FRFA'') in accordance with section 3(a) of the 
Regulatory Flexibility Act.\272\ It relates to rule 202(a)(11)-1.
---------------------------------------------------------------------------

    \272\ 5 U.S.C. 603(a).
---------------------------------------------------------------------------

A. Reasons for Action

    Sections I through III of this Release describe the reasons for and 
objectives of rule 202(a)(11)-1. As discussed in detail above, rule 
202(a)(11)-1(a) is designed to permit broker-dealers to offer new types 
of accounts, which charge asset-based or fixed fees for full-service 
brokerage services or make available discount brokerage services, 
without unnecessarily triggering regulation under the Advisers Act. 
Rule 202(a)(11)-1(b) identifies three situations in which provision of 
investment advisory services to broker-dealers' customers is not 
``solely incidental to'' brokerage business within the meaning of the 
broker-dealer exception from the definition of an investment adviser in 
section 202(a)(11)(C) of the Advisers Act or within the exception 
provided by rule 202(a)(11)-1(a), making the broker-dealer ineligible 
for the exception from the definition of an investment adviser in 
section 202(a)(11)(C) of the Advisers Act, and making such advisory 
services ineligible for the fee-based account exception under rule 
202(a)(11)-1(a).\273\ Our objectives with rule 202(a)(11)-1 include 
fostering the availability of fee-based and discount brokerage programs 
to brokerage customers and reducing investor confusion as to whether 
they are receiving brokerage services or advisory services.\274\
---------------------------------------------------------------------------

    \273\ First, a broker-dealer that charges a separate fee or 
separately contracts with a customer for investment advisory 
services may not rely on the exception. Second, a broker-dealer that 
holds itself out generally to the public as a financial planner or 
as providing financial planning services may generally not rely on 
the exceptions to avoid registration under the Act, and a broker-
dealer that delivers a financial plan to a customer or represents to 
a customer that its advice is part of a financial plan or in 
connection with financial planning services must also generally 
register under the Act and treat that customer as an advisory 
client. Third, a broker-dealer may not rely on the exceptions for 
any accounts over which it exercises investment discretion. See rule 
202(a)(11)-1(b).
    \274\ Section X of this Release lists the statutory authority 
for the proposed rule and rule amendments.
---------------------------------------------------------------------------

B. Significant Issues Raised by Public Comment

    We received no comments on our IRFA. We discuss comments we 
received on the substantive rulemaking above.\275\
---------------------------------------------------------------------------

    \275\ See Sections II and III of this Release, supra.
---------------------------------------------------------------------------

C. Small Entities

    Rule 202(a)(11)-1 applies to all brokers-dealers registered with 
the Commission, including 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.\276\
---------------------------------------------------------------------------

    \276\ 17 CFR 240.0-10(c).
---------------------------------------------------------------------------

    The Commission estimates that as of December 31, 2003, 
approximately 905 Commission-registered broker-dealers were small 
entities.\277\ The Commission assumes for purposes of this FRFA that 
all of these small entities could rely on the exceptions provided by 
rule 202(a)(11)-1(a), although it is not clear how many would actually 
do so. Additionally, it is not clear how many of these small entities 
would be affected by proposed rule 202(a)(11)-1(b), which results in 
certain advisory services not being exempt from the Advisers Act.\278\ 
Therefore, for purposes of this FRFA, the Commission also assumes that 
all of these small entities could be affected by the new rules.
---------------------------------------------------------------------------

    \277\ This estimate is based on the most recent data available, 
taken from information provided by broker-dealers 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.
    \278\ See supra note 273 for a description of these three 
categories of advisory services.
---------------------------------------------------------------------------

D. Reporting, Recordkeeping, and Other Compliance Requirements

    The provisions of rule 202(a)(11)-1(a), pertaining to fee-based and 
discount brokerage accounts, impose no new reporting or recordkeeping 
requirements, and will not materially alter the time required for 
broker-dealers to comply with the Commission's rules. Rule 202(a)(11)-
1(a) is designed to prevent unnecessary regulatory burdens from being 
imposed on broker-dealers. Broker-dealers taking advantage of rule 
202(a)(11)-1(a) with respect to fee-based brokerage accounts will be 
required to make certain disclosures to customers and potential 
customers in advertising and contractual materials. Under Exchange Act 
rules, however, broker-dealers are already required to maintain these 
documents as ``written agreements * * * with respect to any account.'' 
\279\
---------------------------------------------------------------------------

    \279\ 17 CFR 240.17a-4(b)(7). As previously discussed, although 
rule 202(a)(11)-1(a) would also limit its application to accounts 
that a broker-dealer does not exercise investment discretion over, 
under Exchange Act rules, broker-dealers are already currently 
required to maintain all ``evidence of the granting of discretionary 
authority given in any respect of any account.'' 17 CFR 240.17a-
4(b)(6). Thus, this provision of the rule would not create an 
additional recordkeeping requirement for broker-dealers.
---------------------------------------------------------------------------

    Under rule 202(a)(11)-1(b), advisory services provided by broker-
dealers will be outside the broker-dealer exception from the Advisers 
Act under three scenarios. Thus, broker-dealers providing advisory 
services as described in any of these three scenarios will be subject 
to the Advisers Act.\280\ Although some broker-dealers providing 
advisory services as described in one or more of these three scenarios 
are already registered as investment advisers, rule 202(a)(11)-1(b) 
will result in other broker-dealers having to newly register as 
advisers, and will subject these brokers to the reporting, 
recordkeeping, and other compliance requirements under the Advisers 
Act.\281\ For these broker-dealers, registration under the Advisers Act 
and compliance with its requirements will constitute new reporting, 
recordkeeping, and other compliance requirements. For broker-dealers 
already registered as investment advisers, rule 202(a)(11)-1(b) will 
require that broker-dealers treat affected accounts as advisory 
accounts. Thus, for these broker-dealers, rule 202(a)(11)-1(b) will 
impose new reporting, recordkeeping, and other compliance

[[Page 20453]]

requirements with respect to these accounts.
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    \280\ See supra note 273 for a description of these three 
scenarios.
    \281\ For Paperwork Reduction Act purposes, we have estimated 
that approximately 195 broker-dealers could be required to register 
as investment advisers as a result of the proposed rule and 
interpretation. See supra Section VIII.B of this Release.
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    Small entities registered with the Commission as broker-dealers 
will be subject to these new reporting, recordkeeping, and other 
compliance requirements to the same extent as larger broker-dealers. In 
developing these requirements over the years, we have analyzed the 
extent to which they would have a significant impact on a substantial 
number of small entities, and included flexibility wherever possible in 
light of the requirements' objectives, to reduce the corresponding 
burdens imposed.

E. Duplicative, Overlapping, or Conflicting Federal Rules

    The Commission believes that there are no rules that duplicate or 
conflict with rule 202(a)(11)-1.

F. Significant Alternatives

    The Regulatory Flexibility Act directs the Commission to consider 
significant alternatives that would accomplish the stated objectives, 
while minimizing any adverse impact on small entities.\282\ In 
connection with rule 202(a)(11)-1, the Commission considered the 
following alternatives: (i) The establishment of differing compliance 
or reporting requirements or timetables that take into account the 
resources available to small entities; (ii) the clarification, 
consolidation, or simplification of compliance and reporting 
requirements under the rule for such small entities; (iii) the use of 
performance rather than design standards; and (iv) an exemption from 
coverage of the rule, or any part thereof, for such small entities.
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    \282\ 5 U.S.C. 603(c).
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    With respect to the first alternative, the Commission presently 
believes that establishment of differing compliance or reporting 
requirements or timetables for small entities would be inappropriate in 
these circumstances. The provision rule 202(a)(11)-1(a) requiring 
prominent disclosures to customers and potential customers is designed 
to prevent investors from being confused about the nature of the 
services they are receiving. To specify less prominent disclosures for 
small entities would only serve to diminish investor protection to 
customers of small broker-dealers. Such a course would be inconsistent 
with the purposes of the Advisers Act. With respect to rule 202(a)(11)-
1(b), the compliance and recordkeeping requirements are those generally 
applicable to any adviser registered under the Act. In developing these 
requirements over the years, the Commission has analyzed the extent to 
which they would have a significant impact on a substantial number of 
small entities, and included flexibility wherever possible in light of 
the requirements' objectives, to reduce the corresponding burdens 
imposed. It would be inconsistent with this design, and contrary to its 
purpose, to create special rules for small broker-dealers who would be 
subject to the Act as a result of proposed rule 202(a)(11)-1(b).
    With respect to the second alternative, the Commission presently 
believes that clarification, consolidation, or simplification of the 
compliance and recordkeeping requirements under proposed rule 
202(a)(11)-1(a) for small entities unacceptably compromises the 
investor protections of the rule. As discussed above, the rule's 
prominent disclosure requirement is designed to prevent investor 
confusion. We believe this requirement is already adequately clear and 
simple for those seeking to make use of the rule's exception for fee-
based accounts. To further consolidate this requirement would 
potentially impede our objective of preventing investor confusion. With 
respect to rule 202(a)(11)-1(b), clarification, consolidation, or 
simplification would involve modification of the compliance and 
recordkeeping requirements generally applicable to registered 
investment advisers under the Act. As discussed above in connection 
with the first alternative, the Commission, in developing these 
requirements over the years, has included as much flexibility as can be 
introduced in light of the investor protection objectives underlying 
them.
    With respect to the third alternative, the Commission presently 
believes that the compliance requirements contained in rule 202(a)(11)-
1 already appropriately use performance standards instead of design 
standards. The rule is crafted to make regulation under the Advisers 
Act turn on the services offered by a broker-dealer rather than 
strictly on the type of compensation involved. Thus, eligibility for 
rule 202(a)(11)-1(a)'s exception hinges on the services offered by the 
broker-dealer. Likewise, under rule 202(a)(11)-1(b), the treatment of 
the advisory activities in question also focus on the services 
offered.\283\ The reporting, recordkeeping, and other compliance 
requirements stemming from these of rule 202(a)(11)-1 are triggered by 
the performance of services by the entity in question, including small 
businesses.
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    \283\ Rule 202(a)(11)-1(b)(1) focuses on whether the broker-
dealer separately contracts for the advisory services or charges a 
separate fee. Rule 202(a)(11)-1(b)(2) focuses on how the broker-
dealer holds itself out generally to the public or represents its 
services to a customer. Rule 202(a)(11)-1(b)(3) focuses on whether 
the broker-dealer exercises investment discretion over customer 
accounts.
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    Finally, with respect to the fourth alternative, the Commission 
presently believes that exempting small entities would be 
inappropriate. To the extent rule 202(a)(11)-1(a) eliminates 
unnecessary regulatory burdens that might otherwise be imposed on 
broker-dealers, 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. Furthermore, the 
Commission believes the provisions of rule 202(a)(11)-1(b) should apply 
to small entities to the same extent as larger ones. Rule 202(a)(11)-
1(b) is grounded in the view that the advice described in the rule's 
three scenarios is not solely incidental to brokerage. Because the 
protections of the Advisers Act are intended to apply equally to 
clients of both large and small advisory firms, it would be 
inconsistent with the purposes of the Advisers Act to exempt small 
entities further from the rule.

X. Statutory Authority

    The Commission is adopting rule 202(a)(11)-1 pursuant to sections 
202(a)(11)(F) and 211(a) of the Advisers Act.\284\
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    \284\ 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 
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).
    We also have authority under section 206A, which is available as 
an alternative ground, because the rule we are adopting is in the 
public interest and consistent with the protection of investors and 
the purposes intended in the Act.
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Text of Rule

List of Subjects in 17 CFR Part 275

    Investment advisers, Reporting and recordkeeping requirements.


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 as follows:


[[Page 20454]]


    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)-1 is added to read as follows:


Sec.  275.202(a)(11)-1  Certain broker-dealers.

    (a) Special compensation. 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''):
    (1) Will not be deemed to be an investment adviser based solely on 
its receipt of special compensation (except as provided in paragraph 
(b)(1) of this section), provided that:
    (i) 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 
(including, in particular, that the broker or dealer does not exercise 
investment discretion as provided in paragraphs (b)(3) and (d) of this 
section); and
    (ii) Advertisements for, and contracts, agreements, applications 
and other forms governing, accounts for which the broker or dealer 
receives special compensation include a prominent statement that: 
``Your account is a brokerage account and not an advisory account. Our 
interests may not always be the same as yours. Please ask us questions 
to make sure you understand your rights and our obligations to you, 
including the extent of our obligations to disclose conflicts of 
interest and to act in your best interest. We are paid both by you and, 
sometimes, by people who compensate us based on what you buy. 
Therefore, our profits, and our salespersons' compensation, may vary by 
product and over time.'' The prominent statement also must identify an 
appropriate person at the firm with whom the customer can discuss the 
differences.
    (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) Solely incidental to. A broker or dealer provides advice that 
is not solely incidental to the conduct of its business as a broker or 
dealer within the meaning of section 202(a)(11)(C) of the Advisers Act 
or to the brokerage services provided to accounts from which it 
receives special compensation within the meaning of paragraph (a)(1)(i) 
of this section if the broker or dealer (among other things, and 
without limitation):
    (1) Charges a separate fee, or separately contracts, for advisory 
services;
    (2) Provides advice as part of a financial plan or in connection 
with providing financial planning services and:
    (i) Holds itself out generally to the public as a financial planner 
or as providing financial planning services;
    (ii) Delivers to the customer a financial plan; or
    (iii) Represents to the customer that the advice is provided as 
part of a financial plan or in connection with financial planning 
services; or
    (3) Exercises investment discretion, as that term is defined in 
paragraph (d) of this section, over any customer accounts.
    (c) Special rule. 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.
    (d) Investment discretion. For purpose of this section, the term 
investment discretion has the same meaning as given in section 3(a)(35) 
of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(35)), except 
that it does not include investment discretion granted by a customer on 
a temporary or limited basis.

    Dated: April 12, 2005.

    By the Commission.
Jill M. Peterson,
Assistant Secretary.
[FR Doc. 05-7641 Filed 4-18-05; 8:45 am]
BILLING CODE 8010-01-P