Court Rules That SEC Exceeded Authority With Decision Regarding IAA Exemption

The U.S. Court of Appeals for the District of Columbia Circuit ruled last week that the U.S. Securities and Exchange Commission went beyond its authority to promulgate a rule exempting broker-dealers that offer investment advice to clients with fee-based accounts from regulation under the 1940 Investment Advisers Act.

The SEC had adopted the Investment Adviser/Broker-Dealer Rule, IAA Rule 202(a)(11)-1 in 2005, but the ruling was subsequently challenged by the Financial Planning Association. The court ruled in the FPA’s favor, citing exemptions, such as the broad definition of the term “investment adviser.” The court also said that the rule failed to meet certain requirements for an exemption to be consistent with the IAA. In addition, Judge Judith Rogers noted that the U.S. Congress had already addressed this “precise issue at hand.”

This is the third time in less than 12 months that the court has ruled against the SEC. Merril Hirsch, the FPA’s chief attorney said the ruling was a significant victory for consumers. He also said that any uncertainty resulting from vacating the rule was nothing compared to the uncertainty created by the broker-dealer rule.

Now that the rule has been vacated, however, new rules need to be promulgated that conform to the court’s decision. The general counsel for the Securities Industry Financial Markets Association, Ira Hammerman, said that the SIFMA is urging firms affected by the decision to offer customers as much disclosure as is reasonable in light of the ruling.

This decision is important because brokerage firms are charging more and more clients based on a percentage of assets rather than commissions for each trade. While this sounds good, instead of “churning” accounts for commissions, brokerage firms are charging 1% to 2% on assets – which is 10% to 20% in 10 years! Often these firms just stick the clients into accounts managed by others who use computers to buy and sell stocks for thousand of clients at a time. The firms pay them a portion of the fee and then ignore what goes on.

An active broker who does nothing but gather assets can gather up a client per week, over 10 years, with an average of -say $100,000 – and thus have $50 million under management. This would produce $500,000 to $1 million dollars per year in gross commissions. All this is fine, except that the brokers often do nothing to truly watch over the needs of their 500 clients as they have promised and as is required.

The bottom line on this case is that brokerage firms such as Merrill Lynch wanted their brokers to be do all the things investment advisors do, but have them be exempt from the regulations concerning them. (Thus, this was called the “Merrill Lynch” Rule.) Primarily, Merrill Lynch and others did not want to have a statutory “fiduciary duty” to their clients. (A fiduciary duty is an affirmative duty to out their clients’ interest before their own.)]

This case determined that the brokerage firms have the same duties to their clients as financial planners do when they are acting as financial advisors, rather than just acting as discount brokerage firms, to make the orders that the clients place.

Shepherd Smith and Edwards is a law firm committed to protecting such clients and making sure that they don’t incur financial losses as a result of brokers not correctly fulfilling their fiduciary duties to them. We have helped thousands of investors recover their losses. Contact Shepherd Smith and Edwards today for your free consultation.

Related Web Resources:

Financial Planning Association v. Securities and Exchange Commission (Read the Decision)

US court strikes down SEC broker exemption rule, Reuters, March 30, 2007