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SAMPLE QUESTIONS FOR EXPERT MASON A. DINEHART
WHEN
BROKERS
SHOULD BE HELD TO A FIDUCIARY STANDARD
PLEASE
STATE YOUR OCCUPATION
BRIEFLY
DESCRIBE YOUR EDUCATIONAL BACKGROUND
PLEASE
DESCRIBE YOUR EMPLOYMENT EXPERIENCE
WHICH
SECURITIES LICENSES DO YOU HOLD OR HAVE YOU HELD
DO
YOU HAVE ANY PRIORS ON YOUR RECORD
YOU
WERE ASKED TO REVIEW THE ACCT. HISTORY OF MR.
WHAT
DOCUMENTS HAVE YOU REVIEWED
DID
YOU REVIEW ANY BACKGROUND INFORMATION ON MR.
DID
YOU HAVE AN OPPORTUNITY TO SPEAK WITH MR.
WHAT
IS YOUR UNDERSTANDING OF HIS BACKGROUND
WHAT
IS YOUR UNDERSTANDING OF HIS PRIOR INVESTMENT EXPERIENCE
IN
YOUR OPINION DOES A BROKER OWE ANY DUTY TO HIS CLIENT
WHAT
IS YOUR UNDERSTANDING OF THAT DUTY (FIDUCIARY DUTY)
HAVE
YOU HEARD OF THE TERM "DUE DILIGENCE"
WHAT
DOES THIS MEAN IN THE CONTEXT OF THE SECURITIES SOLD TO MR.
BASED
ON YOUR TRAINING AND EXPERIENCE, YOUR REVIEW OF THE DOCUMENTS IN THIS CASE
AND YOUR DISCUSSIONS WITH THE CLAIMANT, HAVE YOU FORMED ANY OPINIONS AS TO
WHETHER THERE HAS BEEN A BREACH OF FIDUCIARY DUTY WITH RESPECT TO MR.
WHAT
ARE THEY (FAILURE TO KNOW YOUR CUSTOMER, EXCESSIVE TRADING, EXCESSIVE
UNDISCLOSED COMPENSATION, OVER CONCENTRATION IN NASDAQ MICRO-CAP STOCKS,
UNSUITABILITY & FAILURE TO SUPERVISE).
WHEN
DEALING WITH UNSUITABILITY, ARE THE INVESTMENT OBJECTIVES OF AN INVESTOR
IMPORTANT
WHY
WHEN
HE OPENED HIS ACCOUNT WITH XYZ SECURITIES, WHAT WERE HIS INVESTMENT
OBJECTIVES
WHAT
WAS HIS AGE & INCOME
WHAT
WAS HIS TOTAL AND LIQUID NET WORTH
DO
YOU BELIEVE THAT THIS ACCOUNT WAS CHURNED.
WHAT
IS CHURNING
WHAT
ELEMENTS ARE CONSIDERED TO BRING A CASE FOR CHURNING AGAINST A
BROKER/BROKERAGE FIRM
WERE
THESE ELEMENTS PRESENT DURING THE RESPECTIVE MONTHS THAT THESE ACCOUNTS
WERE ACTIVELY TRADED AT HIS FIRM(S)
WAS
CONTROL INDICATED HERE IN EACH CASE
WHAT
KIND OF CONTROL
WAS
SCIENTER PRESENT HERE
WHAT
IS SCIENTER
WAS
EXCESSIVE TRADING INDICATED
WHAT
WAS THE ANNUALIZED TURNOVER RATIO
WHAT
WAS THE COST TO EQUITY RATIO
WHAT
WAS THE BREAKDOWN, BY PERCENTAGE, OF THE NASDAQ AND PENNY STOCKS
WERE
MANY OF THESE HIGHLY SPECULATIVE
DID
YOU PERFORM ANY INDIVIDUAL ANALYSIS TO DETERMINE THIS TO BE TRUE (SCORECARD
MASTER - BACKGROUND AND INDIVIDUAL SCORECARDS - COMMON STOCKS/IPO'S/MUTUAL
FUNDS/REITS/L.P.S)
HOW
LONG WERE THE ISSUES HELD BY THE BROKER, ON AVERAGE BEFORE SELLING THEM
DO
YOU BELIEVE THAT THOSE RECOMMENDATIONS WERE SUITABLE FOR HIM
WAS
THE ACCOUNT 0VERCONCENTRATED IN ONE ASSET CLASS, TYPE OF SECURITY OR
DIVERSIFIED
WAS
THE TOTAL COMPENSATION TO XYZ SECURITIES REFLECTED ON THE CONFIRMATIONS
I.E. SALES CREDITS TO THE BROKER
DOES
THE SEC REQUIRE ALL COMPENSATION TO BE DISCLOSED (SEC RULE 10B-10)
DO
YOU HAVE AN OPINION AS TO WHETHER THIS ACCOUNT WAS PROPERLY SUPERVISED
WERE
ANY ACTIVITY LETTERS SENT TO THE INVESTOR
DID
THEY REQUIRE ANY INITIALS, SIGNATURE OR POSITIVE RESPONSE FROM MR.(I.E.
WERE THEY NEGATIVE CONSENT LETTERS)
DID
THE BROKERAGE FIRM (BR. MGR.) FOLLOW UP ON THE LETTER(S) BY DIRECT CONTACT
WITH THE INVESTOR
WHEN
THE FIRM BECAME AWARE OF THIS SPECULATIVE ACTIVITY IN HIS ACCOUNT, DID THEY
TAKE APPROPRIATE ACTION TO STOP SUCH ACTIVITY
WERE
ANY OF THE TRADES LABELED "UNSOLICITED" ON THE CONFIRMS
WHAT
IS THE IMPORTANCE OF THIS
IS
LABELING A TRADE "UNSOLICITED" WHEN ITS ACTUALLY SOLICITED A
VIOLATION OF ANY SEC OR NASD RULE
HAVE
ANY RULES IN THE FIRMS COMPLIANCE MANUAL BEEN VIOLATED
WERE
PHONE CALLS/LETTERS SENT TO THE BROKER/BROKERAGE FIRM
BASED
ON YOUR TRAINING AND EXPERIENCE AND YOUR REVIEW OF THE WRITTEN MATERIALS IN
THIS CASE, DO YOU BELIEVE THAT THE INVESTOR HAS SUFFERED ANY DAMAGES AS A
RESULT OF THE CONDUCT THAT YOU HAVE DESCRIBED HERE
DID
YOU PERFORM ANY CALCULATIONS TO DETERMINE THE EXTENT OF THOSE DAMAGES (GO
THROUGH CALCULATIONS)
DID
YOU TAKE INTO CONSIDERATION DISTRIBUTIONS & LOST OPPORTUNITY
WHAT
IS TOTAL RETURN ANALYSIS
DO
YOU FEEL IT WOULD BE APPROPRIATE IN THIS CASE
YOU
WERE HIRED BY MR. TO REVIEW HIS ACCOUNT AND TESTIFY HERE TODAY
WHAT
ARE YOU CHARGING HIM
WHEN BROKERS SHOULD BE HELD TO A FIDUCIARY STANDARD
Broker/Dealers, who support the industry's 658,000 financial advisors, have
maintained over the past 65 to 70 years that their brokers have had no
fiduciary responsibility for any advice their brokers might render, and that
any advice is just incidental to the trade execution services provided by
the broker/dealer. This stance has come to be known as the
"Merrill Lynch Rule". The distinction between brokers
and advisors has always been that brokers only make the customer aware of
their investment alternatives and execute trades, while advisors provide
both implementing and monitoring services, thereby adding value.
The SEC has ruled (SEC Rule 202 (a) (11)-1) that on April 15, 2005 (1) a broker who charges a separate
fee or enters into a separate contract for advisory services is held to a
fiduciary standard. (2) a broker who provides financial planning
services is held to a fiduciary standard and (3) a broker who has discretion
over any brokerage account is held to a fiduciary standard. New
disclosure requirements have also been passed. Essentially, the rules
now require that brokers who "are" offering investment advice be
held to the same fiduciary standard as advisors. .
The SEC has thereby established three criteria that will determine whether
the broker who "is" providing advice will be held to a fiduciary
standard: (1) the services being offered, (2) the brokers relationship with
the client, and (3) how brokers and their supporting broker/dealers
represent their services. In other words, brokers who directly control
(on a de facto basis) accounts might well be subject to the same fiduciary
standard
Through time, customers of brokerage firms have demanded this
clarification. Every client wants their advisor to evaluate their
holdings before they make an investment recommendation so that they can
determine if the recommendation adds value. Every client wants their
broker/advisor to disclose their role and responsibilities, and that of the
money manager and other vendors, along with any conflicts and to clarify the
duties of the client. Every client wants full disclosure and their
best interests to be put first, ahead of all others. Every client
wants their advisor to continuously and comprehensively monitor their
holdings as required by regulatory mandate. Given, every client wants
and expects these basic fiduciary services, it is difficult to imagine how a
broker would compete without providing these services. It seems clear
that brokers and advisors both would have to be held to a fiduciary
standard, if the broker is to compete in the free marketplace of financial
services. The law is already on the books for advisors. The Investment
Advisors Act of 1940 charges advisors with the obligation for those advisors
to "exclusively act in the best interests of the consumer with the
skill, care and diligence of a prudent expert". Brokers who do
fee business, made possible by holding a Series 65 or Series 66 license (Investment
Advisor Representative - IAR license), should fall
under the same fiduciary standard.
The reality of all of this is that brokers who "are" providing
advice should be held to a fiduciary standard and therefore, their
broker/dealers will be obligated to create a prudent process which will
"continuously and comprehensively" address and manage the full
range of investment and administrative values, as required by regulatory
mandate and client directive. Clearly, when a broker has a
relationship of trust and confidence with their client (the only type of
client relationship worth having) the broker should be held to a fiduciary
standard. There are tens of thousands of brokers within large full
service brokerage firms, that characterize their services as being
financial planning - which the SEC now holds to an objective fiduciary
standard. If the SEC is to enforce the fiduciary status of
broker/advisors who are in a trust position, who are providing financial
planning services and/or providing investment advice, the broker/advisors
firm has two choices. Either to absolutely ban those activities, which
would cause a significant backlash from broker/advisors who are ethically
compelled to do the right thing, or create and support a prudent process
that promulgates fiduciary counsel in the truest sense.
There are six financial services that make up the prudent process of
fiduciary counsel. They are (1) asset/liability study, (2) investment
policy, (3) strategic asset allocation, (4) manager/vendor search and
selection, (5) performance monitoring and (6) tactical asset
allocation. Only through these critical steps, can a broker/advisor
truly add value in ways not possible without a total understanding the
client and their holdings. In other words, without the rule
clarification and these steps, it is impossible for the broker/advisor to
meet the responsibility of NYSE Rule 405, the "know your customer
rule".
Clients know that it is the process, or what the broker/advisor does with
the investment products, that adds the value, not the investment products
themselves. And by extension, this also means that the prudent process
designed to add value and fulfill fiduciary responsibility, preempts
investment products, which when sold, as isolated disjointed transactions,
make it impossible for the broker/advisor to add value.
The SEC finds itself having to strike a balance between two countervailing
forces: the best interests of the broker/dealer versus that of the customer
- which by definition compromises consumer protection. The fiduciary
responsibilities of advisors are already on the books, they are just waiting
to be enforced. To date, the consumers best interests have not been
placed before that of supporting broker/dealers. We are in an
environment where leadership is demanded, where doing the right thing is
more important than creating legal constructs that cleverly circumvent
fiduciary responsibility. The SEC is now
shifting the balance of the scale of consumer protection back to the
customer, which ultimately is in the best interests of the advisor and the
industry. Without question, brokers do render investment advice
........just ask them. They should be held to a fiduciary
standard. Fiduciary responsibility is in the investors best interest,
is a preemptive value proposition for the broker/advisor, is required by
regulatory mandate and is the right thing to do.
Brokers are now required to register with the SEC as investment advisors if, as described above, they hold themselves out to the
public as financial planners or as providing financial services. They
are further required to register as investment advisors if they offer
discretionary accounts to their customers. .
Clarification of SEC Rule 202 (a) (11)-1 - William Mack, a senior
assistant administrator of regulation with the SEC's Philadelphia district
office clarified the following aspects of the rule. "If a B/D's
rep had merely assisted a client in reviewing their current financial
situation, they could avoid registering as an investment advisor.
However, if the advisor had prepared a comprehensive program for the client,
then the advisor would have to register".
BACKGROUND & IMPLICATIONS OF THE MERRILL LYNCH RULE
Under Federal Law, there are two sets of statutes in place for
regulating financial service professionals. The Securities Exchange
Act of 1934 controls the activities of broker-dealers while the Investment
Advisers Act of 1940 regulates investment advisers. It is important to
distinguish the two from each other in order to understand their functions,
the requirements they lay out as obligations to the client as well as how
they are affected by the Merrill Lynch Rule.
The U.S. congress passed the Securities Exchange Act in 1934 in response to
the "Great Depression" and loss of confidence in the financial
markets. The Securities Exchange Act defines a broker as a person
"engaged in the business of effecting transactions in securities for
the account of others." Conversely, a dealer is defined as a
person "engaged in the business of buying and selling securities for
[its] own account. "Brokerage services" have been
interpreted by the SEC to encompass:
"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 record-keeping services."
Only a broker-dealer may perform these tasks of executing securities for
clients.
The Investment Advisors Act of 1940 (the '40 Act) was enacted with the
purpose of protecting investors and the general public from receiving poor
securities advice. See Johnston v. CIGNA Corp. 916 P.2d 643,
646 (Colo. Ct. App. 1996) (stating the purpose of the Investment Advisers
Act of 1940). The Advisers Act provided regulation in a highly
unregulated securities market after the Commission submitted the
"Investment Council Report" to Congress. The Report
recognized two main problems among investment advisers: "(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. The Advisers Act
helped resolve these problems and sought to distinguish certain
professionals from investment advisers.
As background, up until the end of World War I, customers paid fixed
commissions for investment advice. Later, in 1920, investment advice
was offered for a separate and specific fee. As a result, it was easy
to differentiate broker-dealers from those who received "special
compensation." However, in today's environment, the line between
brokers and financial advisors has been blurred.
The Advisers Act defines "investment adviser" as "[A]ny
person who, for compensation engages in the business of advising others,
either directly or through publications or writing, 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 regulator
business, issues or promulgates analyses or reports concerning
securities..."
This appears to include a variety of professionals, from those who publish
stock tips online to those who manage complex investment portfolios.
In SEC v. Capital Gains Research Bureau, the Supreme Court stated
that an investment adviser's function is "furnishing to clients on a
personal basis competent, unbiased, and continuous advice regarding the
sound management of their investments." See, SEC v.
Capital Gains Research Bureau, 375 U.S. 180 187 (1963).
The fundamental purpose of this and other legislation adopted at the time
was to "substitute a philosophy of full disclosure for the philosophy
of caveat emptor and thus achieve a standard of business ethics in the
securities industry." The Investment Advisors Act in particular
arose from a "consensus between industry and the SEC that investment
advisers could not completely perform their basic function - furnishing to
clients on a personal basis competent, unbiased, and continuous advice
regarding the sound management of their investments - unless all conflicts
of interest between investment counsel and their client were removed.
Then, what is the significance of being registered as an "investment
adviser"? The law is clear that investment advisers are
fiduciaries. As a fiduciary, the investment advisers must place the
client's interest ahead of his own interest. The duty of care, the
duty of loyalty and the duty of fair dealing capture much of the essence of
what it means to be a fiduciary. Additionally, it is worth noting that
the fiduciary duties of investment adviser's is governed by
rules other than contract rules. Whenever the two conflict, fiduciary
rules trump contract rules.
In the beginning, there was Leib v. Merrill Lynch. Though
written in 1978 by a federal district court judge sitting in the Eastern
District of Michigan, and though contradicted by some court decisions
rendered since then, brokerage firms continue to cite the case in securities
arbitration proceedings to this day. Brokerage firms seize upon the
court's language that, in a non-discretionary account, "all duties to
the customer cease when the transaction is closed." Moreover,
brokerage firms quote Leib's language that a broker "has no continuing
duty to keep abreast of financial information which could influence his
investments." In short, this view stands for the proposition that
brokers are responsible only for executing trades properly, with no duty to
offer advice or warnings about investments.
In today's environment of "full service" firms, it would seem that
virtually every broker at a major wire-house would be deemed a financial
advisor. However, Section 80b-2(a)(11)of the Advisors Act provides
exceptions under which these professionals can avoid its
provisions. The Broker-Dealer Exception provides that "any broker
or dealer whose performance of such services is solely incidental to the
conduct of his business as a broker or dealer and who receives no special
compensation therefore..." is exempt from the Advisors Act. It is
this exemption that the Merrill Rule discusses and it clearly favors Wall
Street and its continual attempts to receive high commissions with no
responsibility.
The Merrill Rule was created to determine when a broker-dealers activities
are subject to the Advisers Act. The rule was developed in response to
the increased use of fee-based wrap accounts. Fee-based brokerage
programs provide brokerage services packages for an asset-based fee or a
fixed-fee. Packages normally include investment advice. The
benefit of fee-based programs if that they discourage churning of
accounts. Churning is a problem in commission-based compensation
because broker-dealers are tempted to sell packages that will provide them
with the greatest commission rather than acting in what is necessarily the
customer's best interests. Contrarily, the fee-based programs often
result in an increase in "reverse churning". Broker-dealers
under this program no longer have greater commissions as motivation to act
so it is common that they remain idle when account activity would actually
be more proper.
The trend towards the use of "wrap accounts" gained significant
momentum when Merrill Lynch announced its new Unlimited Advantage program in
1999-- a change to traditional brokerage programs because it was to charge
an asset-based fee in lieu of a commission. The program was necessary
because other brokerage firms were offering services for under $10 per each
trade, and the public was no longer as willing to pay Merrill's hefty
commissions. Although many were happy that customer and broker
interests would be more appropriately aligned due to a decrease in churning,
Merrill Lynch soon realized that its new program would subject it to the
Advisers Act. Merrill was obviously selling advice when it advertised
that a "Financial Consultant 'will help you develop investment
strategies', including including retirement planning, saving for college,
estate preservation and liability-management strategies. In an attempt
to increase the usage of these programs, then SEC Chairman Arthur Levitt
proposed to exempt broker-dealer advisory services from the Adviser's Act
regulation. thus, the new Rule 202(a)(11)-1 has been dubbed the
"Merrill Rule."
The SEC first proposed the Merrill Rule on November 4, 1999 under the name
"Certain Broker-Dealers Deemed Not To Be Investment
Advisors." Under this new rule, those broker-dealers who are not
excepted from the Advisers Act must register under the Act and treat their
clients with advisory accounts as advisory clients rather than regular
brokerage customers.
Under this initial proposal, the Rule provided that broker-dealers are not
considered investment advisers under the Advisers Act regardless of any
compensation received as long as 1) the advice given is not discretionary;
2) the advice given is solely incidental to the brokerage services provided
and 3) the broker-dealer discloses to his customers that their accounts are
brokerage rather than advisory accounts. Immediately after its
proposal in 1999, the Merrill Rule became the source of significant
controversy. In fact, after the first proposal, the Commission
received more than 1,700 comment letters. Not surprisingly, a strong
majority of broker-dealers supported the Rule under the guise that the new
fee-based brokerage programs better consider customer interests.
Moreover, broker-dealers believed that the Rule encouraged development of
these new programs because the industry would not be susceptible to the more
stringent rules of the Advisers Act. In opposition, financial
planners, investment advisors, and those groups who represent investors were
against the Rule because it decreases the level of investor
protection. The SEC allowed different parties to comment on the
proposal for an additional month in August 2004 in order to accommodate late
letters, and then considered them for approximately three months.
After reviewing the many comment letters, the SEC revised the Rule and
submitted a re-proposal in January 2005. The re-proposed rule included
a few notable changes. For example, under the re-proposal, the Merrill
Rule now includes greater disclosure requirements in response to commenters'
concerns about investor confusion on the differences between broker-dealers
and investment advisers. In addition, the Merrill Rule now requires
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. The disclosure must
also include an explanation of the customer's rights and the firm's duties
to the customer, including the appropriate standard of obligation. The
following statement must be displayed clearly on all client documents:
"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 by both 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.."
Furthermore, broker-dealers are now required to make available a person
within their firm to answer any customer questions on the above
issues. The re-proposed rule also attempted to appease commenters' who
worried about when, specifically, advisory services are not "solely
incidental to" brokerage services. The SEC responded by
stating that investment advice is "solely incidental to" brokerage
services when the advice is reasonably related to the regular brokerage
services (which of course, provided no real guidance). The Commission
also interpreted that financial planning services are not necessarily "solely
incidental to" brokerage services. Finally, the Commission
mandated that when a broker-dealer exercises investment discretion over a
client's account, he is no longer providing advice that is "solely
incidental to" the business of brokerage under the Advisers
Act.
In relation to financial planning, the re-proposed Merrill Rule states that
a broker-dealer's advice is not solely incidental to brokerage services if
it provides some type of financial plan or services "and (i) holds
itself out generally to the public as a financial planner or as providing
financial planning services; 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." In sum,
if a broker-dealer advertises financial planning services, he must register
under the Advisers Act.
Surprisingly, other than the above restriction, there are no other
restrictions on how a broker holds himself out to the public. A broker
may creatively title himself any way he chooses without facing liability
under the Advisers Act. Even the illusory terms "financial
advisor" and "financial consultant" are allowed under the new
Rule. The Commission came to the this conclusion based on the fact
that professionals in other related industries such as banks and insurance
companies typically utilize such "generic" terms to describe a wide
variety of different services. The SEC has determined that requiring
broker-dealers to notify advisory clients of the stricter legal obligations
is sufficient to protect investors.
In the final analysis, the SEC concluded, the role that the broker plays
depends on the circumstances.
In its SEC filing, UBS (PaineWebber) took the position that while its
financial reports for customers "contain some elements of investment
advice", nonetheless. "the planning analysis and recommendations
cover a variety of other topics that do not involve general or specific
investment advice at all and for which investment adviser regulation is
neither appropriate or required." Likewise, Citigroup Global
Markets (Smith Barney) took the position that its fee-based (not
commissioned-based) AssetOne account "is a brokerage account and not an
investment adviser account."
Since those declarations in in 2004 and 2005, brokers have filed class
action lawsuits alleging that their brokerage firms violated the Fair Labor
Standards Act and state wage hour statutes in failing to pay them
overtime. Many cases are still pending and some cases have
settled. For example, Citigroup Global Markets and UBS agreed to
settle nationally, paying $98 million and $89 million, respectively.
Morgan Stanley and Merrill Lynch settled in California but in no other
states, paying $43.5 million and $37 million, respectively.
However, one firm, A.G. Edwards, filed a motion for summary judgment.
A.G. Edwards argued that commission-based brokers are not entitled to
overtime. The federal; district court in California denied the motion
for summary judgment in its entirety.
As background, the Fair Labor Standards Act (FLSA) exempts certain employees
from overtime pay requirements, so long as the employer proves that the
employee meets both of two tests: the salary-basis test and the duties
test. In its motion for summary judgment, A.G. Edwards argued that its
brokers were paid a guaranteed salary, in effect, because the firm paid them
a draw against future commissions. The court rejected that argument
that the draw was the equivalent of a guaranteed salary, reasoning that,
"Case law and the DOL [Department of Labor] letters cited by both
parties, therefore, appear to support that deduction of Plaintiff's draw
salary from a subsequent paycheck is an impermissible
offset."
Turning to the duties test, A.G. Edwards attempted to convince the court
that the primary duties of its brokers were "administrative", as
distinguished from "sales", such that they fell within one of the
duties exemptions to overtime pay requirements. A.G. Edwards claimed,
among other things, that that its brokers underwent extensive training on
management of client portfolios, "only a small portion of which focused
on prospecting." Of course, the argument that brokers had a duty
to manage client portfolios flew in the face of Leib and was inconsistent
with positions taken more recently that investment advice is "solely
incidental" to the brokerage (sales) function. In any event, the
court relied on testimony and documents suggesting that the primary duty of
A.G. Edwards' brokers was to sell. Accordingly, the court found that
there was a genuine issue of material fact "regarding whether
Plaintiffs are engaged in work that results from the product that Defendant
profits from, in this case sales of securities and other financial
offerings, rather than in the administration of Defendant's business or that
of its existing customers."
What
then are the roles and responsibilities of brokers? Yes, the answer
(that brokerage firms provide) depends upon the circumstances. But one
thing is clear. What brokerage firms for years have claimed about
their brokers' limited duties to customers, now, in the context of broker
class action lawsuits for overtime pay, may come back to haunt
them.
On
March 30, 2007, the Merrill Lynch Rule was overturned in a 2-1 decision
released by the U.S. Court of Appeals for the District of Columbia Circuit
in Washington. The decision is a big win for the Financial Planning
Association of Denver, which challenged the SEC when it issued its rule in
2005 exempting brokerage firms that charge asset-based fees from investment
advisory regulations under specified conditions. The ruling issued by
Judge Judith Rogers for herself and Judge Brett Kavanaugh said the SEC
exceeded its authority by exempting brokerage firms that charge asset-based
fees from regulation under the Investment Advisors Act of 1940.
"The rules is inconsistent with the IAA", Judge Rogers wrote,
because it fails to meet the law's requirements for exemptions.
Under
that law, she wrote, brokers can only be exempt from advisory regulation if
they do not receive "special compensation" for giving
advice. Charging asset-based fees (special compensation) means they
must register as advisers. "No...indicators of congressional
intent support the SEC's interpretation of its authority," Judge Rogers
wrote. Judge Merrick Garland, who dissented, said that the SEC's
interpretation of the IAA was reasonable and courts are bound by legal
precedent to give government regulators the benefit of the doubt in
interpreting the law.
The
ruling is "very straightforward" and a "clean decision"
commented David Tittsworth, executive director of the Investment Advisors
Association in Washington. "This is throwing the rule
out." The decision opens the door for Congress to re-examine the
securities laws in light of changes that have taken place in the industry
since those laws were enacted in the Depression era. "It looks to
me like Congress probably will need to get into this fray to sort it
out," Mr.Tittsworth said. "This rule should have died a
quick and merciful death six years ago," said FPA President
Nicholas A. Nicolette. "It would not be the best use of taxpayer
dollars to prolong a policy that is contrary to the public
interest.".
The
appeals court's decision forces the broker-dealer to stop selling
fee-based accounts and advice without having to register as advisors.
Brokers have sold an estimated whopping $300 billion in fee-based accounts
in the past eight-plus years under the SEC-ordered exemption.
currently, broker-dealers will only have three months to
"re-paper" these accounts. "What we're going back to is
the bright-line test that existed for consumers before 1999," says FPA
Director of Government Relations Duane Thompson. "if a broker is
offering advice for fees, they must be registered."
FEND
- Securities Expert Witness
Telephone:
(310)641-0377
FAX: (310)649-3663
Email: fendmase@ca.rr.com
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