I'm talking about a proposed revision in the Securities & Exchange Commission's rules defining the differences between a stockbroker and an investment adviser. The formal title of this proposal is "Certain Broker-Dealers Deemed Not To Be Investment Advisers." After nearly three years, it remains on the SEC's back burner as regulators struggle to keep up with everything else that's boiling over. But from all signs, the SEC still plans to move ahead with the new rule.
The logic for this change traces the shape of a pretzel, so please follow closely. Under a 1940 law, anyone who both offers investment advice and charges an asset-based or flat fee has been required to register as an investment adviser. The point was to distinguish advisers from stockbrokers. Advisers, the law holds, must act as fiduciaries--putting clients' best interests before their own and disclosing any conflicts of interest. As fiduciaries, investment advisers are expected to be on the client's side of the negotiating table in any deal.
Brokers, of course, have their own burdens under other rules, among them to offer customers only suitable investments and to treat them fairly. But Congress saw brokers as essentially different. Instead of acting as fiduciaries, they are agents of the firms they work for. They may offer the odd stock tip or some occasional advice, but regulators viewed that as incidental to a broker's main business of accumulating trades and commissions. A broker's first duty is to the firm, not the customer.
But as the bad behavior among too many brokers accumulated over the years and imperiled the term "stockbroker," new marketing guises cropped up. Here's how Merrill Lynch (MER
) describes its "Unlimited Advantage" brokerage account on its Web site: "Gain the advantages of an asset-based fee structure. Consult with a Financial Advisor to target your investment goals, identify your investor profile, and develop an asset-allocation strategy. Your Financial Advisor will work with you to create a financial plan." So Merrill's "Financial Advisor" sounds like much more than a broker. A spokesman said: "We use the title `Financial Advisor' because the law permits us to, and we believe it accurately reflects the full panoply of services that we offer."
The trouble is, since 1999, when Merrill Lynch introduced Unlimited Advantage, offering trades, advice, and asset-based fees, the rules would have forced the firm to register its brokers as investment advisers. The same would be true for the other firms, such as Morgan Stanley (MWD
) and Salomon Smith Barney (C
), that also now offer advice in a brokerage account for a flat fee.
Why would brokers not want to register as investment advisers? Because they would have to operate differently--as fiduciaries, not agents--and disclose much crucial information. Brokers can sell securities to customers from a firm's own inventories without revealing how the trade might benefit the firm. If a broker sells a municipal bond to a customer from the firm's own portfolio, for example, he or she need not tell the customer how much its price was marked up. An investment adviser would have to spell that out.
Wall Street found sympathetic ears in Washington. The SEC has been promoting asset-based fees as a way to discourage "churning," or unwarranted trading, by unscrupulous brokers bent on keeping their commissions flowing. When Wall Street's plea to escape the rules for investment advisers met Washington's hope for more asset-based fees, the proposed rule was conceived. Even as it's pending, many brokers are being exempted from having to register as investment advisers.
When the SEC finally acts on the proposal, chances are it will insist that Wall Street's marketing materials make much plainer than they do that a brokerage account, whether fee- or commission-based, is no more than that and not an advisory service. Yet given the Street's outrageous behavior and Washington's inept oversight, I hold no hope that most individual investors will see through this masquerade. By Robert Barker