Commission Interpretation Regarding the Solely Incidental Prong of the Broker-Dealer Exclusion From the Definition of Investment Adviser, 33681-33689 [2019-12209]
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Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations
conflict.92 Further, we believe that any
potential costs or market effects
resulting from investment advisers
addressing conflicts of interest may be
decreased by the flexibility advisers
have to meet their federal fiduciary duty
in the context of the specific scope of
services that they provide to their
clients, as discussed in this Final
Interpretation.
The commenter also drew particular
attention to the question of whether the
Commission’s discussion of the
fiduciary duty in the Proposed
Interpretation applied to advisers to
institutional clients as well as those to
retail clients. The same commenter
indicated that failing to accommodate
the application of the concepts in the
Proposed Interpretation to sophisticated
clients could risk changing the
marketplace or limiting investment
opportunities for sophisticated clients,
increasing compliance burdens for
advisers to sophisticated clients, or
chilling innovation. As explained above,
this Final Interpretation, as compared to
the Proposed Interpretation, discusses
in more detail the ability of investment
advisers and different types of clients to
shape the scope of the relationship to
which the fiduciary duty applies.93 In
particular, this Final Interpretation
acknowledges that while advisers owe
each of their clients a fiduciary duty, the
specific obligations of, for example, an
adviser providing comprehensive,
discretionary advice in an ongoing
relationship with a retail client will be
significantly different from the
obligations of an adviser to an
institutional client, such as a registered
investment company or private fund,
where the contract defines the scope of
the adviser’s services and limitations on
its authority with substantial
specificity.94
Finally, to the extent this Final
Interpretation causes some investment
advisers to reassess their compliance
with their duty of loyalty, it could lead
to a reduction in the expected
profitability of advice relating to
particular investments for which
compliance costs would increase
following the reassessment.95 As a
result, the number of investment
advisers willing to advise a client to
make these investments may be
reduced. A decline in the supply of
investment adviser advice regarding
these types of investments could affect
efficiency for investors; it could reduce
the efficiency of portfolio allocation for
those investors who might otherwise
benefit from investment adviser advice
regarding these types of investments
and are no longer able to receive such
advice. At the same time, if providing
full and fair disclosure and appropriate
monitoring for highly complex products
(e.g., those with a complex payout
structure, such as those that include
variable or contingent payments or
payments to multiple parties) results in
these products becoming less profitable
Subject
Release No.
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*
*
Commission Interpretation Regarding Standard of
Conduct for Investment Advisers.
IA–5248
[Release No. IA–5249]
BILLING CODE 8011–01–P
Commission Interpretation Regarding
the Solely Incidental Prong of the
Broker-Dealer Exclusion From the
Definition of Investment Adviser
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1. Part 276 is amended by adding
Release No. IA–5428 and the release
date of June 5, 2019, to the end of the
list of interpretive releases to read as
follows’’
■
95 For example, such products could include
highly complex, high cost products with risk and
return characteristics that are hard for retail
investors to fully understand, or where the
investment adviser and its representatives receive
complicated payments from affiliates that create
conflicts of interest that are difficult for retail
investors to fully understand.
SUMMARY:
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PART 276—INTERPRETATIVE
RELEASES RELATING TO THE
INVESTMENT ADVISERS ACT OF 1940
AND GENERAL RULES AND
REGULATIONS THEREUNDER
The Securities and Exchange
Commission (the ‘‘SEC’’ or the
‘‘Commission’’) is publishing an
Securities and Exchange
Commission.
ACTION: Interpretation.
supra section II.A.
For the reasons set out above, the
Commission is amending Title 17,
chapter II of the Code of Federal
Regulations as set forth below:
interpretation of a section of the
Investment Advisers Act of 1940 (the
‘‘Advisers Act’’ or the ‘‘Act’’), which
excludes from the definition of
‘‘investment adviser’’ any broker or
dealer that provides advisory services
when such services are ‘‘solely
incidental’’ to the conduct of the broker
or dealer’s business and when such
incidental advisory services are
provided for no special compensation.
DATES: Effective July 12, 2019.
FOR FURTHER INFORMATION CONTACT:
James McGinnis, Senior Counsel,
Investment Adviser Regulation Office, at
(202) 551–6787 or IArules@sec.gov; and
Benjamin Kalish, Attorney-Advisor, or
AGENCY:
94 See
Amendments to the Code of Federal
Regulations
*
*
[Insert FR Volume Number] FR [Insert FR Page
Number].
[FR Doc. 2019–12208 Filed 7–11–19; 8:45 am]
text.
Securities.
*
*
June 5, 2019 .................
17 CFR Part 276
supra section II.C.
supra footnotes 78–81 and accompanying
List of Subjects in 17 CFR Part 276
FR vol. and page
SECURITIES AND EXCHANGE
COMMISSION
93 See
for investment advisers, investment
advisers may be discouraged from
supplying advice regarding such
products. However, investors may
benefit from (1) no longer receiving
inadequate disclosure or monitoring for
such products, (2) potentially receiving
advice regarding other, less complex or
expensive products that may be more
efficient for the investor, and (3) only
receiving recommendations for highly
complex or high cost products for which
an investment adviser can provide full
and fair disclosure regarding its
conflicts and appropriate monitoring.
Date
By the Commission.
Dated: June 5, 2019.
Vanessa A. Countryman,
Acting Secretary.
92 See
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Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations
Parisa Haghshenas, Branch Chief, Chief
Counsel’s Office at (202) 551–6825 or
IMOCC@sec.gov, Division of Investment
Management, Securities and Exchange
Commission, 100 F Street NE,
Washington, DC 20549–8549.
SUPPLEMENTARY INFORMATION: The
Commission is publishing an
interpretation of the solely incidental
prong of the broker-dealer exclusion in
section 202(a)(11)(C) of the Advisers Act
[15 U.S.C. 80b].1
Table of Contents
I. Introduction
II. Interpretation and Application
A. Historical Context and Legislative
History
B. Scope of the Solely Incidental Prong of
the Broker-Dealer Exclusion
C. Guidance on Applying the Interpretation
of the Solely Incidental Prong
III. Economic Considerations
A. Background
B. Potential Economic Effects
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I. Introduction
The Advisers Act regulates the
activities of certain ‘‘investment
advisers,’’ who are defined in section
202(a)(11) of the Advisers Act in part as
persons who, for compensation, engage
in the business of advising others about
securities. Section 202(a)(11)(C)
excludes from the definition of
investment adviser—and thus from the
application of the Advisers Act—a
broker or dealer ‘‘whose performance of
such advisory services is solely
incidental to the conduct of his business
as a broker or dealer and who receives
no special compensation’’ for those
services (the ‘‘broker-dealer exclusion’’).
The broker-dealer exclusion shows, on
the one hand, that at the time the
Advisers Act was enacted Congress
recognized broker-dealers commonly
provided some investment advice to
their customers in the course of their
business as broker-dealers and that it
would be inappropriate to bring brokerdealers within the scope of the Advisers
Act because of this aspect of their
business.2 On the other hand, the
limitations of the exclusion show that
Congress excluded broker-dealer
advisory services from the scope of the
Advisers Act only under certain
circumstances—namely, when those
services are solely incidental to the
broker-dealer’s regular business as a
1 15 U.S.C. 80b. Unless otherwise noted, when we
refer to the Advisers Act, or any paragraph of the
Advisers Act, we are referring to 15 U.S.C. 80b of
the United States Code, at which the Advisers Act
is codified.
2 Opinion of 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) (‘‘Advisers Act Release No. 2’’).
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broker-dealer (the ‘‘solely incidental
prong’’) and when the broker-dealer
receives no special compensation (the
‘‘special compensation prong’’).3
On April 18, 2018, the Commission
proposed a rulemaking intended to
enhance the standard of conduct for
broker-dealers when providing
recommendations.4 The Commission
also proposed an interpretation
intended to reaffirm and in some cases
clarify the standard of conduct for
investment advisers,5 as well as a
rulemaking intended to provide retail
investors with clear and succinct
information regarding key aspects of
their brokerage and advisory
relationships.6 The Reg. BI Proposal
discussed the broker-dealer exclusion
and requested comment on the scope of
the exclusion as applied to a brokerdealer’s exercise of investment
discretion.7 While some commenters
addressed when a broker-dealer’s
advisory services are ‘‘solely incidental
to the conduct of his business as a
broker or dealer’’ in the context of the
exercise of investment discretion, more
commenters addressed this prong more
generally.8 For example, many
3 See Regulation Best Interest, Securities
Exchange Act Release No. 83062 (April 18, 2018)
[83 FR 21574 (May 9, 2018)] (‘‘Reg. BI Proposal’’),
at n.343. The broker-dealer exclusion is
conjunctive—that is, the broker-dealer must both
provide investment advice that is solely incidental
to the conduct of his business as a broker-dealer
and the broker-dealer must receive no special
compensation. In the event that a broker-dealer’s
investment advice fits within the guidance of this
Release with respect to the solely incidental prong,
that broker-dealer must also receive no special
compensation for the advisory service to be
consistent with the broker-dealer exclusion.
4 See id.
5 Proposed Commission Interpretation Regarding
Standard of Conduct for Investment Advisers;
Request for Comment on Enhancing Investment
Adviser Regulation, Investment Advisers Act
Release No. 4889 (April 18, 2018) [83 FR 21203
(May 9, 2018)] (the ‘‘Proposed Fiduciary
Interpretation’’).
6 See Form CRS Relationship Summary;
Amendments to Form ADV; Required Disclosures in
Retail Communications and Restrictions on the Use
of Certain Names or Titles, Investment Advisers Act
Release No. 4888 (April 18, 2018) [83 FR 21416
(May 9, 2018)] (‘‘Relationship Summary Proposal’’).
Concurrently with this interpretation, we also are
adopting the final versions of the rules and
interpretations proposed in the Relationship
Summary Proposal, the Reg. BI Proposal, and the
Proposed Fiduciary Interpretation. See Form CRS
Relationship Summary; Amendments to Form ADV,
Investment Advisers Act Release No. 5247 (June 5,
2019) (the ‘‘Relationship Summary Adoption’’);
Regulation Best Interest: The Broker-Dealer
Standard of Conduct, Exchange Act Release No.
86031 (June 5, 2019) (‘‘Reg. BI Adoption’’); and
Commission Interpretation Regarding Standard of
Conduct for Investment Advisers, Investment
Advisers Act Release No. 5248 (June 5, 2019)
(‘‘Final Fiduciary Interpretation’’).
7 See Reg. BI Proposal, supra footnote 3, at
nn.342-67 and accompanying text.
8 We considered comments submitted in File No.
S7–07–18 (Reg. BI Proposal, supra footnote 3); File
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commenters requested general guidance
on or expressed views about the
meaning of the solely incidental prong 9
and the permissibility under this prong
of various broker-dealer activities that
relate to the investment advice they
provide in light of the Reg. BI Proposal
and the Relationship Summary
Proposal.10 Other commenters suggested
that our approach to the Reg. BI
Proposal was inconsistent with the
solely incidental prong of the brokerdealer exclusion. One commenter
suggested that the Reg. BI Proposal, if
adopted, would allow broker-dealers to
provide investment advice beyond what
the solely incidental prong should
‘‘reasonably be interpreted to permit,’’
arguing that to qualify for exclusion
from regulation under the Advisers Act,
broker-dealers should only ‘‘be able to
provide very limited advice. . . .’’ 11
Two commenters thought that the
Commission’s expressed support for
maintaining the ‘‘broker-dealer model as
an option for retail customers seeking
investment advice’’ 12 was inconsistent
with the solely incidental prong.13
No. S7–08–18 (Relationship Summary Proposal,
supra footnote 6); and File No. S7–09–18 (Proposed
Fiduciary Interpretation, supra footnote 5). Those
comments are available on the Commission’s
website at https://www.sec.gov/comments/s7-07-18/
s70718.htm, https://www.sec.gov/comments/s7-0818/s70818.htm, and https://www.sec.gov/
comments/s7-09-18/s70918.htm, respectively.
9 See, e.g., Comment Letter of North American
Securities Administrators Association, Inc. (Aug.
23, 2018) (‘‘NASAA Letter’’); Comment Letter of
CFA Institute (Aug. 7, 2018) (‘‘CFA Institute
Letter’’) (noting the ‘‘need to give guidance’’ on the
broker-dealer exclusion and noting that the
Commission has legal authority to provide needed
clarification); Comment Letter of the Institute for
the Fiduciary Standard (Aug. 6, 2018) (‘‘IFS Letter’’)
(arguing that when a broker’s investment advice is
solely incidental to its business is one of a number
of ‘‘questions the SEC should address’’); Comment
Letter of the Consumer Federation of America (Aug.
7, 2018) (‘‘CFA Letter’’) (arguing that the
Commission failed to ‘‘engage’’ on ‘‘just how far the
‘solely incidental’ exclusion stretches’’); Comment
Letter of the Investment Adviser Association (Aug.
6, 2018) (‘‘IAA Letter’’) (‘‘[T]he Commission should
reconsider when broker-dealers should be able to
rely on the Solely Incidental [prong].’’); Comment
Letter of Michael Kitces (Aug. 2, 2018) (‘‘Kitces
Letter’’) (arguing that the Commission’s prior
interpretations of the solely incidental prong are
inconsistent with the plain meaning and legislative
history of the term).
10 See, e.g., CFA Letter; Kitces Letter.
11 See NASAA Letter.
12 See Reg. BI Proposal, supra footnote 3, at text
accompanying n.31.
13 See CFA Letter (stating that certain aspects of
the Relationship Summary Proposal and the Reg. BI
Proposal indicated that broker-dealers were in an
‘‘advice relationship’’ in a manner that does not
‘‘remotely sound like advice that is ‘solely
incidental to’ the conduct of their business as a
broker or dealer’’); Kitces Letter (arguing that
referring to the broker-dealer model as a ‘‘model for
advice’’ is in contravention of the broker-dealer
exclusion because ‘‘advice can only be incidental if
it occurs by chance, as a consequence of a product
sale, or without intent to give advice’’).
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Another commenter called the
Commission’s previously articulated
interpretation of the solely incidental
prong ‘‘vague.’’ 14 The comments we
received demonstrate that there is
disagreement about when the provision
of broker-dealer investment advice is
consistent with the solely incidental
prong.15 In light of these comments, we
are adopting this interpretation to
confirm and clarify the Commission’s
position with respect to the solely
incidental prong. To illustrate how the
interpretation functions, we discuss its
application to two advisory services that
a broker or dealer may provide, namely:
(i) Exercising investment discretion over
customer accounts and (ii) account
monitoring.16 Our interpretation
complements each of the rules and
forms we are adopting, which, among
other things, are intended individually
and collectively to enhance investor
understanding of the relationships and
services offered by investment advisers
and broker-dealers.17
14 See Comment Letter of Securities Arbitration
Clinic, St. Vincent DePaul Legal Program, Inc., St.
John’s University School of Law (Aug. 7, 2018) (‘‘St.
John’s Clinic Letter’’).
15 Furthermore, interested parties have for years
expressed their views to the Commission on what
they believe the broker-dealer exclusion requires,
including disagreements with the Commission’s
interpretation of the exclusion. See, e.g., Comment
Letter of Consumer Federation of America (Sept. 20,
2004) (arguing that the Commission should ‘‘define
‘solely incidental’ in a way that hews closely to
what commenters described as Congress’s clear
intent to provide only a very narrow exclusion’’),
available at https://www.sec.gov/rules/proposed/
s72599/s72599-1101.pdf.
16 We received comments requesting guidance
with respect to the solely incidental prong on both
activities. See infra section II.C.
17 See Reg. BI Adoption; Relationship Summary
Adoption; Final Fiduciary Interpretation, supra
footnote 6. We also received a few comments in
response to the Reg. BI Proposal and the
Relationship Summary Proposal requesting that the
Commission provide guidance on the special
compensation prong. See, e.g., CFA Letter (arguing,
among other points, that special compensation
would constitute any compensation other than
commissions for trade execution); Comment Letter
of Coalition of Mutual Fund Investors (Aug. 8,
2018) (‘‘Mutual Fund Investors Letter’’) (arguing
that special compensation should include all assetbased compensation and third-party fees from
mutual funds and their advisers). We are not
providing guidance on the special compensation
prong in this Release as we do not believe our views
on this prong require additional clarification. The
Commission has considered the meaning of the
special compensation prong on previous occasions.
See, e.g., Interpretive Rule Under the Advisers Act
Affecting Broker-Dealers, Investment Advisers Act
Release No. 2652 (Sept. 24, 2007) (‘‘2007 Proposing
Release’’); Certain Broker-Dealers Deemed Not to Be
Investment Advisers, Investment Advisers Act
Release No. 2376 (Apr. 12, 2005) (‘‘2005 Adopting
Release,’’ in which, as discussed infra at footnote
38 and accompanying text, the Commission
adopted a rule that a court vacated on grounds that
did not address our interpretive positions relating
to the solely incidental prong). The comments we
received in response to requests for comment to the
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II. Interpretation and Application
A. Historical Context and Legislative
History
When the Advisers Act was enacted
in 1940, broker-dealers regularly
provided investment advice.18 They did
so in two distinct ways: As an auxiliary
part of 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.19 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.20 ‘‘Brokerage house
advice’’ was extensive and varied,21 and
included information about various
corporations, municipalities, and
governments; 22 broad analyses of
Reg. BI Proposal and the Relationship Summary
Proposal did not demonstrate that there is
significant disagreement with our interpretation of
that prong.
18 For an extensive discussion of broker-dealer
practice in the years leading up to enactment of the
Advisers Act, from which this summary is drawn,
see 2005 Adopting Release, supra footnote 17;
Certain Broker-Dealers Deemed Not to Be
Investment Advisers, Investment Advisers Act
Release No. 2340 (Jan. 6, 2005) (‘‘2005 Proposing
Release’’).
19 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.’’).
20 See Twentieth Century Fund, The Security
Markets (1935) (‘‘Security Markets’’) at 633–46
(discussing ‘‘brokerage house advice’’); see also
Charles F. Hodges, Wall Street (1930) (‘‘Wall
Street’’) at 253–85; SEC, Report on Investment
Counsel, Investment Management, Investment
Supervisory, and Investment Advisory Services
(1939) (H.R. Doc. No. 477) (‘‘Investment Counsel
Report’’) at n.1.
21 See, e.g., Report of Public Examining Bd. on
Customer Protection to N.Y. Stock Exchange (Aug.
31, 1939), at 3: 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.
22 Security Markets, supra footnote 20, at 633;
Wall Street, supra footnote 20, 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
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33683
general business and financial
conditions; 23 market letters and special
analyses of companies’ situations; 24
information about income tax schedules
and tax consequences; 25 and ‘‘chart
reading.’’ 26 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 firms whose sole
business was providing ‘‘investment
counsel’’ services.27
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,
including broker-dealers with
investment advisory departments.28 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
of the company and much other information of
value to the investor in appraising the value of a
security.’’).
23 Security Markets, supra footnote 20, at 634;
Wall Street, supra footnote 20, at 254.
24 Security Markets, supra footnote 20, at 640–43;
Wall Street, supra footnote 20, at 277–85.
25 Security Markets, supra footnote 20, at 641.
26 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’’).
27 See Advisers Act Release No. 2, supra footnote
2; see also Security Markets, supra footnote 20, 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
Advisers Act, ‘‘investment counsel’’ is a defined
subset of the ‘‘investment advisers’’ to whom the
Act applies. See section 208(c) of the Act.
28 Investment Counsel Report, supra footnote 20,
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]; see Hearings on S. 3580,
supra footnote 19, at 995–96.
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institutions.’’ 29 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 persons
engaged in the business of providing
investment advice for compensation.
Congress responded 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 30
should be free from any oversight
except, perhaps, by the few states that
had passed laws regulating investment
counselors and by private organizations,
such as the Investment Counsel
Association of America.31 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.32
29 Investment Counsel Report, supra footnote 20,
at 27.
30 Hearings on S. 3580, supra footnote 19, at 745–
48; see also 2005 Adopting Release, supra footnote
17, at n.62.
31 Hearings on S. 3580, supra footnote 19, at 716–
18, 736–38, 740–41, 744–45, 760, 763.
32 Id. 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 SEC. 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. Id. at 995–96. Eventually, members of the
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Conversely, the Advisers Act
specifically excluded persons, among
others, from the broad definition of
‘‘investment adviser’’ to the extent that
such persons rendered investment
advice incidental to their primary
business.33 Broker-dealers were among
these excluded persons, as section
202(a)(11)(C) of the Act excludes 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’’—i.e., the
broker-dealer exclusion.
B. Scope of the Solely Incidental Prong
of the Broker-Dealer Exclusion
The Commission and its staff have on
several occasions discussed the scope of
the broker-dealer exclusion.34 In
adopting a rule regarding fee-based
brokerage accounts in 2005, for
example, the Commission stated that
investment advisory services are ‘‘solely
incidental to’’ the conduct of a brokerdealer’s business when the services are
offered in connection with and are
reasonably related to the brokerage
services provided to an account.35 The
interpretation was consistent with the
Commission’s contemporaneous
construction of the Advisers Act as
excluding broker-dealers whose
investment advice is given ‘‘solely as an
investment counsel industry agreed with the
proposed legislation. See id. at 1124; 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. (1940) (‘‘Hearings on H.R.
10065’’); see also S. Rep. No. 76–1775, 76th Cong.,
3d Sess. 21 (1940); H.R. Rep. No. 76–2639, 76th
Cong., 3d Sess. 27 (1940).
33 The exclusion for certain professionals in
Advisers Act section 202(a)(11) 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) reprinted in Hearings
on S. 3580, supra footnote 19, at 1007. That report
stated that ‘‘the investment advice furnished by
these excepted groups would seem to be merely
incidental to some other function being performed
by them.’’ Id.
34 See, e.g., Advisers Act Release No. 2, supra
footnote 2; Applicability of the Investment Advisers
Act to Certain Brokers and Dealers; Interpretation
of the Term ‘Special Compensation’, Investment
Advisers Act Release No. 640 (Oct. 5, 1978);
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).
35 2005 Adopting Release, supra footnote 17; 2005
Proposing Release, supra footnote 18.
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incident of their regular business.’’ 36
The 2005 interpretation stated that the
importance or frequency of the
investment advice was not a
determinant of whether the solely
incidental prong was satisfied; the
Commission rejected the view that only
minor, insignificant, or infrequent
advice qualifies for the broker-dealer
exclusion, noting that the advice brokerdealers gave as part of their brokerage
services in 1940 was often substantial
and important to customers.37
On March 30, 2007, the Court of
Appeals for the District of Columbia
Circuit in Financial Planning
Association v. SEC vacated the rule
regarding fee-based brokerage accounts,
but not on grounds that addressed our
interpretive positions relating to the
solely incidental prong.38 In September
2007, we proposed to reinstate these
interpretive positions.39
Since that time, a federal appellate
court has addressed the solely
incidental prong. In 2011, in Thomas v.
Metropolitan Life Insurance Company,
the Court of Appeals for the Tenth
Circuit addressed the scope of the
broker-dealer exclusion in the context of
a private suit alleging that a broker had
violated the Advisers Act by failing to
disclose incentives to sell proprietary
products.40 As part of its analysis of the
exclusion, the court looked to the
interpretation of the solely incidental
prong that we advanced in 2005 and
2007. The court found these
interpretations to be ‘‘persuasive’’ in
light of its own analysis of the text of
the solely incidental prong of the
broker-dealer exclusion as well as the
legislative history and historical
background of the Advisers Act.41 The
court concluded that a broker-dealer’s
investment advice is solely incidental to
its conduct as a broker-dealer if the
advice is given ‘‘only in connection
with the primary business of selling
securities.’’ 42 Thus, the court explained,
‘‘broker-dealers who give advice that is
not connected to the sale of securities—
or whose primary business consists of
giving advice—do not meet the [solely
incidental] prong’’ of the broker-dealer
exclusion.43 The court also agreed with
the Commission’s interpretations that
the solely incidental prong does not
36 See Advisers Act Release No. 2, supra footnote
2; see also 2005 Adopting Release, supra footnote
17.
37 See 2005 Adopting Release, supra footnote 17,
at nn.139–42 and accompanying text.
38 See 482 F.3d 481 (D.C. Cir. 2007).
39 2007 Proposing Release, supra footnote 17.
40 631 F.3d 1153 (10th Cir. 2011).
41 Id. at 1163–64.
42 Id. at 1164.
43 Id.
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hinge upon ‘‘the quantum or
importance’’ of a broker-dealer’s advice
but on its relationship to the brokerdealer’s primary business.44 In the
court’s view, ‘‘[t]he quantum or
importance of the broker-dealer’s advice
is relevant only insofar as the advice
cannot supersede the sale of the product
as the ‘primary’ goal of the transaction
or the ‘primary’ business of the brokerdealer.’’ 45
Based on the text and history of the
solely incidental prong, our previous
interpretations of the prong, the Thomas
decision, and the comments we have
received, we are providing the following
interpretation.46 We interpret the
statutory language to mean that a
broker-dealer’s provision of advice as to
the value and characteristics of
securities or as to the advisability of
transacting in securities 47 is consistent
with the solely incidental prong if the
advice is provided in connection with
and is reasonably related to the brokerdealer’s primary business of effecting
securities transactions.48 If a brokerdealer’s primary business is giving
advice as to the value and
characteristics of securities or the
advisability of transacting in securities,
or if the advisory services are not
offered in connection with or are not
reasonably related to the broker-dealer’s
business of effecting securities
transactions, the broker-dealer’s
44 Id.
at 1163.
at 1166. In Thomas, the brokerage firm’s
representative had conducted an analysis of the
plaintiffs’ financial situation and advised them to
purchase a particular financial product based in
part on that analysis. The plaintiffs alleged that the
firm’s policy ‘‘required [representatives] to provide
investment advice to potential customers as a
means to sell more proprietary products’’ and that
this policy was ‘‘so pervasive that [representatives]
allegedly gave financial advice to every customer to
whom they sold a product.’’ Id. at 1157. The Court
rejected the plaintiffs’ contention that these facts
rendered the advice so central to the transaction
that it could not be considered ‘‘solely incidental’’
to it. Because the representative’s advice ‘‘was
closely related to the sale of the [product] and
selling the [product] was the primary object of the
transaction,’’ the Court concluded, the advice was
‘‘solely incidental’’ to the representative’s conduct
as a broker. Id. at 1167.
46 To the extent that this interpretation is
inconsistent with the Commission’s prior
interpretations with respect to the solely incidental
prong, this interpretation supersedes those
interpretations.
47 See Advisers Act section 202(a)(11) (definition
of ‘‘investment adviser’’).
48 Cf. 2005 Adopting Release, supra footnote 17
(‘‘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 . . . when
the advisory services rendered are in connection
with and reasonably related to the brokerage
services provided.’’). We have modified the
wording of our interpretation to make clear that the
broker-dealer’s primary business must also be
effecting securities transactions.
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45 Id.
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advisory services are not solely
incidental to its business as a brokerdealer.49 Whether advisory services
provided by a broker-dealer satisfy the
solely incidental prong is assessed
based on the facts and circumstances
surrounding the broker-dealer’s
business, the specific services offered,
and the relationship between the brokerdealer and the customer.
The quantum or importance of
investment advice that a broker-dealer
provides to a client is not determinative
as to whether or not the provision of
advice is consistent with the solely
incidental prong. Advice need not be
trivial, inconsequential, or infrequent to
be consistent with the solely incidental
prong. Indeed, our simultaneous
adoption of (i) Regulation Best Interest,
which raises the standard of conduct
that applies to broker-dealer
recommendations, and (ii) the
relationship summary, which provides
information about broker-dealer
recommendation services to customers,
underscores that broker-dealer
investment advice can be consequential
even when it is offered in connection
with and reasonably related to the
primary business of effecting securities
transactions.
To illustrate the application of this
interpretation in practice, we provide
the following guidance on the
application of the interpretation to (i)
exercising investment discretion over
customer accounts and (ii) account
monitoring.
C. Guidance on Applying the
Interpretation of the Solely Incidental
Prong
1. Investment Discretion
The Commission has for many years
considered issues related to a brokerdealer’s exercise of investment
discretion over customer accounts and
the extent to which such practices could
be considered solely incidental to the
business of a broker-dealer.50 The
Commission has stated that
discretionary brokerage relationships
‘‘have many of the characteristics of the
relationships to which the protections of
49 Nothing in this interpretation alters the
Commission’s 2006 interpretation of section 28(e) of
the Exchange Act, which, in the context of a client
commission arrangement that otherwise satisfies
section 28(e), permits a broker-dealer to be paid out
of a pool of commissions for its research even if that
broker-dealer did not effect a securities transaction.
See Commission Guidance Regarding Client
Commission Practices Under Section 28(e) of the
Securities Exchange Act of 1934, Securities
Exchange Act Release No. 54165 (July 18, 2006), 71
FR 41978 (July 24, 2006).
50 See Reg. BI Proposal, supra footnote 3, at
nn.343–62 and accompanying text.
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33685
the Advisers Act are important.’’ 51 In
particular, the Commission has
explained that when a broker-dealer
exercises investment discretion, it is not
providing advice to customers that is in
connection with and reasonably related
to effecting securities transactions;
rather, the broker-dealer is making
investment decisions relating to the
purchase or sale of securities on behalf
of customers on an ongoing basis.52 At
the same time, the Commission has
taken the position that some limited
exercise of discretionary authority by
broker-dealers could be considered
solely incidental to their business.53
We requested comment in the Reg. BI
Proposal on a broker-dealer’s exercise of
investment discretion over customer
accounts and the extent to which the
exercise of investment discretion should
be considered solely incidental to the
business of a broker-dealer.54
Commenters agreed that the exercise of
unlimited discretion should not be
considered ‘‘solely incidental’’
investment advice.55 Commenters
expressed varying views, however, on
the extent to which the exercise of
temporary or limited discretion could be
considered solely incidental to the
business of a broker-dealer. Several
commenters suggested that the exercise
of any investment discretion should be
governed by the Advisers Act.56 One
commenter suggested that the
Commission should interpret the solely
incidental prong through the lens of the
definition of ‘‘investment discretion’’ in
section 3(a)(35) of the Securities
Exchange Act of 1934 (the ‘‘Exchange
Act’’),57 noting that section 3(a)(35)
51 Final Extension of Temporary Exemption from
the Investment Advisers Act for Certain Brokers and
Dealers, Investment Advisers Act Release No. 626
(Apr. 27, 1978) (‘‘Advisers Act Release No. 626’’).
52 See 2005 Proposing Release, supra footnote 18.
53 See Reg. BI Proposal, supra footnote 3, at
nn.355–62 and accompanying text. Cf. NASD rule
2510 (allowing discretion only if a customer ‘‘has
given prior written authorization to a stated
individual or individuals . . . in accordance with
[FINRA] rule 3010’’).
54 See Relationship Summary Proposal, supra
footnote 6, at nn.363–67 and accompanying text;
see also id. at nn.343–62 and accompanying text for
a description of the Commission’s historical
approaches.
55 See, e.g., Comment Letter of Financial Planning
Coalition (Aug. 7, 2018) (‘‘FPC Letter’’) (‘‘[A] brokerdealer’s provision of unfettered discretionary
investment advice should never be considered
‘solely incidental’ to its business as a brokerdealer.’’ (emphasis removed)); CFA Letter; IFS
Letter.
56 See, e.g., Comment Letter of Invesco Advisers,
Inc. (Aug. 7, 2018) (‘‘Discretionary management
over an account, whether or not temporary, is not
within the scope of the ‘solely incidental’
exclusion.’’); IAA Letter; CFA Institute Letter.
57 Under Exchange Act section 3(a)(35), a person
exercises ‘‘investment discretion’’ with respect to
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focuses on ‘‘the level of authority,
decision-making ability, influence—and
ultimately, control—an intermediary
has over another’s money’’ and arguing
that those with section 3(a)(35)
investment discretion have a heightened
likelihood of mismanagement and abuse
of another’s money.58 Another
commenter suggested that, while
discretion generally should subject a
broker-dealer to the Advisers Act, there
are certain cases where temporary or
limited discretion does not have the
supervisory or managerial character of
the investment discretion warranting
the protections of the Advisers Act.59
Applying our interpretation of the
solely incidental prong, a brokerdealer’s exercise of unlimited
discretion 60 would not be solely
incidental to the business of a brokerdealer consistent with the meaning of
section 202(a)(11)(C).61 It would be
inconsistent with the solely incidental
prong for broker-dealers to exercise
‘‘investment discretion’’ as that term is
defined in section 3(a)(35) of the
Exchange Act with respect to any of its
accounts, except for certain instances of
investment discretion granted by a
customer on a temporary or limited
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 though 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. 15
U.S.C. 78c(a)(35).
58 See FPC Letter (noting also that several federal
and state courts have used factors similar to those
in section 3(a)(35) to impose a fiduciary standard).
Another commenter also suggested using Exchange
Act section 3(a)(35) ‘‘investment discretion’’ as a
basis for establishing whether discretion is not
solely incidental for purposes of the broker-dealer
exclusion, with an exception for investment
discretion ‘‘that a customer grants on a temporary
or limited basis.’’ See Comment Letter of Pickard
Djinis and Pisarri (Aug. 14, 2018) (‘‘Pickard
Letter’’).
59 See Comment Letter of the Securities Industry
and Financial Markets Association (Aug. 7, 2018)
(‘‘SIFMA Letter’’).
60 We view unlimited investment discretion as a
person having the ability or authority to buy and
sell securities on behalf of a customer without
consulting the customer—i.e., having responsibility
for a customer’s trading decisions.
61 The Commission has in the past stated that the
quintessentially supervisory or managerial
character of investment discretion warrants the
protection of the Advisers Act. See 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); see also 2005 Proposing Release,
supra footnote 18; 2005 Adopting Release, supra
footnote 17.
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basis, as discussed below. A brokerdealer with unlimited discretion to
effect securities transactions possesses
ongoing authority over the customer’s
account indicating a relationship that is
primarily advisory in nature; such a
level of discretion by a broker-dealer is
so comprehensive and continuous that
the provision of advice in such context
is not incidental to effecting securities
transactions.
We recognize, however, that there are
situations where a broker-dealer may
exercise temporary or limited discretion
in a way that is not indicative of a
relationship that is primarily advisory
in nature. Generally, these are situations
where the discretion is limited in time,
scope, or other manner and lacks the
comprehensive and continuous
character of investment discretion that
would suggest that the relationship is
primarily advisory. The totality of the
facts and circumstances would be
relevant to determining whether
temporary or limited discretion is
consistent with the solely incidental
prong. Taking into consideration
specific examples that commenters have
suggested in the past, instances of
temporary or limited investment
discretion that, standing alone, would
not support the conclusion that a
relationship is primarily advisory—and
therefore outside the scope of the solely
incidental prong—include discretion: (i)
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; (ii) 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;
(iii) as to cash management, such as to
exchange a position in a money market
fund for another money market fund or
cash equivalent; 62 (iv) to purchase or
sell securities to satisfy margin
62 Certain changes to money market fund
regulation and operations have been implemented
since our prior interpretations. See Money Market
Fund Reform; Amendments to Form PF, Investment
Company Act Release No. 31166 (Jul. 23, 2014)
(removing an exemption that permitted institutional
non-government money market funds to maintain a
stable net asset value, while maintaining such
exemption for certain other money market funds,
and applying certain fees and gates reforms to
institutional non-government money market funds
and retail money market funds but not to
government money market funds, among other
changes). In light of these changes, differently
categorized money market funds may have different
investment characteristics. Accordingly, we
anticipate that FINRA will be reviewing the
application of the rules that apply to the exercise
of broker-dealer discretion in this context. The
Commission staff also will evaluate broker-dealer
exercise of discretionary cash management to
consider whether additional measures may be
necessary.
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requirements, or other customer
obligations that the customer has
specified; (v) to sell specific bonds or
other securities and purchase similar
bonds or other securities in order to
permit a customer to realize a tax loss
on the original position; (vi) to purchase
a bond with a specified credit rating and
maturity; and (vii) to purchase or sell a
security or type of security limited by
specific parameters established by the
customer. We view these examples of
temporary or limited discretion as
typically consistent with the brokerdealer exclusion because they are in
connection with and reasonably related
to a broker-dealer’s business of effecting
securities transactions and do not
suggest that the broker-dealer’s primary
business is providing investment
advice.
We have previously described a
similar list of situations that we would
consider temporary or limited discretion
that may be consistent with the solely
incidental prong.63 We make three
refinements.
First, we are not including authority
for a period ‘‘not to exceed a few
months’’ relating to the time a brokerdealer may purchase or sell a security or
type of security when a customer is
unavailable for a limited period of time.
Depending on the facts and
circumstances, a period of discretion
lasting a few months may be indicative
of a business or customer relationship
that is primarily advisory in nature.
Second, we would view it as
consistent with our interpretation of the
solely incidental prong for brokerdealers to purchase or sell securities to
satisfy margin requirements, or other
customer obligations that the customer
has specified (new wording italicized).
In our view, there may be similar
obligations to a broker-dealer or a third
party whereby a broker-dealer may be
authorized to make a purchase or sale,
such as a sale to satisfy a collateral call.
Third, we would view it as consistent
with our interpretation of the solely
incidental prong for broker-dealers to
sell specific bonds or other securities in
order to permit a customer to realize a
tax loss on the original position (new
wording italicized). We see no
distinction between bonds or other
securities in this particular context.
2. Account Monitoring
We received several comments
regarding the extent to which a brokerdealer may monitor the status and
63 See 2005 Adopting Release, supra footnote 17,
at nn.178–81 and accompanying text; 2007
Proposing Release, supra footnote 17, at n.13 and
accompanying text.
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performance of a customer’s account
while relying on the broker-dealer
exclusion. Some commenters suggested
that a broker-dealer’s agreement to
provide ongoing monitoring for the
purpose of recommending changes to a
customer’s investments is not an
advisory service that is solely incidental
to the primary securities transaction
business of a broker-dealer and thus the
broker-dealer exclusion should not be
available to broker-dealers who provide
such services.64 Another commenter
suggested that broker-dealers providing
personalized investment advice about
securities on an ongoing basis should
not be able to rely on the broker-dealer
exclusion.65 Commenters also suggested
that providing services that cause
overseen assets to meet the definition of
‘‘regulatory assets under management’’
under Form ADV (i.e., securities
portfolios for which the broker-dealer
provides ‘‘continuous and regular
supervisory or management services’’)
should subject a broker-dealer to the
Advisers Act.66
We disagree with commenters who
suggested that any monitoring of
customer accounts would not be
consistent with the solely incidental
prong. A broker-dealer that agrees to
monitor 67 a retail customer’s account
on a periodic basis for purposes of
providing buy, sell, or hold
recommendations may still be
considered to provide advice in
connection with and reasonably related
to effecting securities transactions.68 In
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64 See
FPC Letter (‘‘[B]roker-dealers that enter into
agreements with retail customers to provide
ongoing monitoring for purposes of recommending
changes in investments should be considered
investment advisers and subject to fiduciary
obligations under the Advisers Act. Entering into an
agreement to provide ongoing monitoring. . . goes
beyond advice that is solely incidental to the
conduct of business as a broker-dealer. . . .’’); IAA
Letter (same quotation as the FPC Letter); IAA
Letter (‘‘[A] broker-dealer that agrees to provide a
retail customer ongoing monitoring for purposes of
recommending changes in investments would not
be providing services that are solely incidental to
its business as a broker-dealer under the 2007
interpretation.’’); Fisher Letter (‘‘Brokers can give
ongoing investment advice . . . yet still not be
required to register as an investment adviser. . . .
[T]he boundaries [between brokers and investment
advisers] have practically been erased.’’).
65 See Mutual Fund Investors Letter (‘‘[The SEC]
should . . . subject broker-dealers to the Advisers
Act when they are providing personalized
investment advice about securities on an ongoing
basis . . . The term ‘solely incidental’ should be
interpreted narrowly and only include personalized
investment advice that is one-time, temporary, or
limited in scope.’’).
66 See IAA Letter; Pickard Letter.
67 The guidance in this section applies when a
broker-dealer agrees to monitor a customer’s
account. See Reg. BI Adoption, supra footnote 6, at
section II.B.2 for a discussion of what constitutes
such an agreement.
68 See id. Monitoring agreed to by the brokerdealer would result in a recommendation to
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contrast, when a broker-dealer,
voluntarily and without any agreement
with the customer, reviews the holdings
in a retail customer’s account for the
purposes of determining whether to
provide a recommendation to the
customer—and, if applicable, contacts
that customer to provide a
recommendation based on that
voluntary review—the broker-dealer’s
actions are in connection with and
reasonably related to the broker-dealer’s
primary business of effecting securities
transactions. Absent an agreement with
the customer (which would be required
to be disclosed pursuant to Regulation
Best Interest), we do not consider this
voluntary review to be ‘‘account
monitoring.’’ 69
We decline to delineate every
circumstance where agreed-upon
monitoring is and is not solely
incidental to a broker-dealer’s brokerage
business. Broker-dealers may consider
adopting policies and procedures that, if
followed, would help demonstrate that
any agreed-upon monitoring is in
connection with and reasonably related
to the broker-dealer’s primary business
of effecting securities transactions. For
example, broker-dealers may include in
their policies and procedures that a
registered representative may agree to
monitor a customer’s account at specific
time frames (e.g., quarterly) for the
purpose of determining whether to
provide a buy, sell, or hold
recommendation to the customer.70
purchase, sell, or hold a security each time the
agreed-to monitoring occurs and would be covered
by Regulation Best Interest. See id. (‘‘For example,
if a broker-dealer agrees to monitor the retail
customer’s account on a quarterly basis, the
quarterly review and each resulting
recommendation to purchase, sell, or hold, will be
a recommendation subject to Regulation Best
Interest.’’).
In agreeing to provide any monitoring services,
broker-dealers should also consider that a brokerdealer that separately contracts or charges a
separate fee for advisory services is providing
investment advice that is inconsistent with the
broker-dealer exclusion. See, e.g., 2005 Adopting
Release, supra footnote 17. Broker-dealers should
also consider that, even where such monitoring is
consistent with the solely incidental prong, the
broker-dealer must also receive no special
compensation for the activity to be eligible for the
broker-dealer exclusion. Broker-dealers receive
special compensation where there is a clearly
definable charge for investment advice. See
Advisers Act Release No. 626, supra footnote 51;
see also Advisers Act Release No. 2, supra footnote
2; 2007 Proposing Release, supra footnote 17
(describing this interpretation as the Commission’s
‘‘longstanding view’’).
69 See Reg. BI Adoption, supra footnote 6, at
section II.B.2.b. Any recommendation made to the
retail customer as a result of such voluntary review
would be subject to Regulation Best Interest. See id.
70 As noted in the Reg. BI Adoption, and
consistent with the relationship summary adopted
in the Relationship Summary Adoption, the scope
and frequency of a broker-dealer’s monitoring is a
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However, such policies and procedures
should not permit a broker-dealer to
agree to monitor a customer account in
a manner that in effect results in the
provision of advisory services that are
not in connection with or reasonably
related to the broker-dealer’s primary
business of effecting securities
transactions, such as providing
continuous monitoring.71 Additionally,
dually registered firms may similarly
consider adopting policies and
procedures that distinguish the level
and type of monitoring in advisory and
brokerage accounts.72
The Commission will consider further
comment on its interpretation of the
solely incidental prong of the brokerdealer exclusion and its application to
certain brokerage activities to evaluate
whether additional guidance might be
appropriate in the future. Based on any
comments received, the Commission
may, but need not, supplement this
interpretation.
III. Economic Considerations
The Commission’s interpretation
above is intended to advise the public
of its understanding of the solely
incidental prong of the broker-dealer
exclusion. The interpretation does not
itself create any new legal obligations
for broker-dealers. Nonetheless, the
material fact relating to the type and scope of
services provided to a retail customer and thus is
required to be disclosed under Regulation Best
Interest. See id. at section II.B.2; cf. Relationship
Summary Adoption, supra footnote 6. A brokerdealer disclosing to a customer that the brokerdealer will provide monitoring constitutes an
agreement to monitor. See supra footnote 67.
71 The two examples of advisory services we
discuss in this Release—investment discretion and
monitoring—cannot be viewed and interpreted in
isolation. For example, it would not be consistent
with the solely incidental prong for a broker-dealer
to exercise unlimited investment discretion over a
customer account even if its monitoring activities
do comport with the solely incidental prong. Thus,
any policies and procedures that a broker-dealer
adopts to ensure that the broker-dealer’s activities
are in connection with and reasonably related to the
broker-dealer’s primary business of effecting
securities transactions similarly should not grant
the broker-dealer the ability or authority to buy and
sell securities on behalf of a customer as part of
periodic account monitoring, except in
circumstances of temporary or limited discretion
that would be consistent with the solely incidental
prong, as discussed above.
72 In the Final Fiduciary Interpretation, we note
that investment advisers may consider whether
written policies and procedures relating to
monitoring would be appropriate under Advisers
Act rule 206(4)–7. See Final Fiduciary
Interpretation, supra footnote 6, at section II.B.3.
Additionally, the Reg. BI Adoption confirms that
a dual registrant is an investment adviser solely
with respect to those accounts for which a dual
registrant provides investment advice or receives
compensation that subjects it to the Advisers Act.
See Reg. BI Adoption, supra footnote 6, at section
II.B.3.d. Determining the capacity in which a dual
registrant is making a recommendation is a facts
and circumstances test. See id.
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Commission recognizes that to the
extent a broker-dealer’s practices are not
consistent with this interpretation of the
solely incidental prong, the
interpretation could have potential
economic effects. We discuss these
effects below.
A. Background
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The Commission’s interpretation
regarding the solely incidental prong of
the broker-dealer exclusion would affect
broker-dealers and their associated
persons as well as the customers of
those broker-dealers, and the market for
financial advice more broadly.73 As of
December 2018, there were
approximately 3,764 registered brokerdealers with over 140 million customer
accounts. In total, these broker-dealers
have over $4.3 trillion in total assets,
which are total broker-dealer assets as
reported on Form X–17a–5.74 Of the
broker-dealers registered with the
Commission as of December 2018, 363
broker-dealers were dually registered
with the Commission as investment
advisers.75 Dual registrant firms hold
over 90 million (63%) of the overall 140
million customer accounts held by
broker dealers.76 As part of the Reg. BI
Proposal, we requested data and other
information related to the nature and
magnitude of discretionary services
offered by broker-dealers,77 but did not
receive any data or information to
inform our analysis of potential
73 See Relationship Summary Adoption, supra
footnote 6, at section IV.B (discussing the market for
financial advice generally).
74 Assets are estimated by Total Assets (allowable
and non-allowable) from Part II of the FOCUS
filings (Form X–17A–5 Part II, available at https://
www.sec.gov/files/formx-17a-5_2.pdf) and
correspond to balance sheet total assets for the
broker-dealer. The Commission does not have an
estimate of the total amount of customer assets for
broker-dealers. We estimate broker-dealer size from
the total balance sheet assets as described above.
75 For purposes of this analysis, a dual registrant
is any firm that is dually registered with the
Commission as an investment adviser and a brokerdealer. Because this number does not include the
number of broker-dealers who are also registered as
state investment advisers, the number undercounts
the full number of broker-dealers that operate in
both capacities.
76 Some broker-dealers may be affiliated with
investment advisers without being dually
registered. From Question 10 on Form BD, 2,098
broker-dealers report that directly or indirectly,
they either control, are controlled by, or under
common control with an entity that is engaged in
the securities or investment advisory business.
Comparatively, 2,691 (19.57%) SEC-registered
investment advisers report an affiliate that is a
broker-dealer in Section 7A of Schedule D of Form
ADV, including 1,916 SEC-registered investment
advisers that report an affiliate that is a registered
broker-dealer. Approximately 74% of total assets
under management of investment advisers are
managed by these 2,691 investment advisers.
77 See Reg. BI Proposal, supra footnote 3.
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economic effects stemming from this
interpretation.
B. Potential Economic Effects
Broker-dealers currently incur
ongoing costs related to compliance
with their legal and regulatory
obligations, including costs related to
understanding their practices and
structuring their practices to be
consistent with the solely incidental
prong of the broker-dealer exclusion.
This interpretation generally confirms
the scope of the solely incidental prong
of the broker-dealer exclusion.
Generally, we believe that few, if any,
broker-dealers take the view that they
act consistently with the solely
incidental prong with respect to any
accounts over which the broker-dealer
exercises more than temporary or
limited investment discretion.78 As with
other circumstances in which the
Commission speaks to the legal
obligations of regulated entities, we
acknowledge that affected firms,
including those whose practices are
consistent with the Commission’s
interpretation, incur costs to evaluate
the Commission’s interpretation and
assess its applicability to them. Further,
to the extent certain broker-dealers
currently understand the scope of
permissible monitoring or other
permissible advisory activities under
the solely incidental prong to be
different from what is set forth in this
interpretation, there could be some
economic effects.79
This interpretation may produce
economic effects to the extent that it
causes any broker-dealers to recognize
that their practices are inconsistent with
the solely incidental prong and to adjust
their practices to make them consistent.
In particular, broker-dealers that have
interpreted the solely incidental prong
to conduct more advisory activities than
this interpretation permits may choose
78 See Comment Letter of UBS (noting that brokerdealers have existing arrangements where they
exercise temporary or limited discretion, such as
discretion as to time and price, and that those types
of discretion ‘‘do not present the sort of risks about
which the SEC is concerned with respect to the
exercise of unfettered discretion’’) (emphasis
added); SIFMA Letter (noting that there are
instances in which temporary or limited discretion,
such as discretion as to prices at which securities
can be purchased, does not have the supervisory or
managerial character of the investment discretion
warranting the protections of the Advisers Act).
79 The above application of our interpretation of
the solely incidental prong to the exercise of
investment discretion is generally consistent with
the position taken in the 2005 Adopting Release
and preliminarily taken in the 2007 Proposing
Release. We believe that many broker-dealers
changed their practices with respect to investment
discretion in light of those releases, and thus those
practices likely are consistent with our
interpretation of the solely incidental prong.
PO 00000
Frm 00372
Fmt 4701
Sfmt 4700
to no longer provide such services to
customers. This could result in a loss of
certain customers, a reduction in certain
business activities, and could preclude
those broker-dealers from further
developing certain services for their
customers, except to the extent those
broker-dealers are dually registered
firms and their customers are also
advisory clients. This may, in turn,
result in decreased competition in the
market for certain services, increased
fees for those services, or a diminished
number of broker-dealers offering
commission-based services to
investors.80
To the extent any broker-dealers have
been providing advisory services
beyond the scope of this interpretation,
their customers may receive fewer
advisory services if these broker-dealers
choose not to register as investment
advisers and adjust their business
practices in light of this interpretation.
To the extent that this interpretation
would lead to a decline in the supply of
certain services offered by brokerdealers (or a decline in broker-dealers
offering services to particular
customers), it could reduce the
efficiency of portfolio construction for
those investors who might otherwise
benefit from broker-dealers providing
investment advice with respect to their
account and would find similar advice
from investment advisers to be too
costly or unattainable (e.g., due to
account minimum requirements). For
example, certain broker-dealers may
incur costs to adopt or revise policies
and procedures to ensure that the
account monitoring that they may agree
to provide their customers is consistent
with this interpretation and may choose
instead to stop offering such monitoring
services. Further, to the extent that any
broker-dealers determine that their
services are not consistent with this
interpretation, they may choose to
register as investment advisers with the
Commission, or one or more states, as
applicable. Such broker-dealers would
bear costs in choosing to register as
investment advisers to continue
providing those services, and their
clients may face higher fees as a result.
Alternatively, broker-dealers that have
investment adviser affiliates may seek to
place existing customers in advisory
accounts instead of brokerage accounts.
Broker-dealers that determine they
must change business practices as a
80 For example, to the extent that broker-dealers
respond to the interpretation by limiting the levels
of discretion that they provide for their customers,
execution quality (including the execution price)
may be affected due to the delays encountered
when the broker-dealer must contact a customer to
proceed with a transaction.
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result of this interpretation will choose
their responses based on their
circumstances. For example, if brokerdealers with affiliated advisers are able
to utilize their existing regulatory
infrastructure and compliance policies
and procedures to account for activities
that are inconsistent with the solely
incidental exclusion they may face
lower costs associated with migration of
brokerage accounts and activities to
investment advisory accounts. By
contrast, we expect the costs of
regulatory registration and compliance
to be greater for any standalone brokerdealers that choose to become registered
investment advisers, as they are more
likely to need to undertake new
systems, procedures, and policies.
To the extent that broker-dealers
choose to discontinue providing certain
services, register as investment advisers,
or encourage migration of customer’s
brokerage accounts to advisory accounts
of affiliates, this interpretation could
result in a shift in the demand for the
services of different types of financial
service providers, decreasing the
demand for services of broker-dealers
and increasing the demand for the
services of investment advisers.81
This interpretation may also produce
some overall economic effects to the
extent that it causes any broker-dealers
that to date have avoided performing
limited discretion and other activities to
recognize that they may perform such
activities consistent with the solely
incidental prong of the broker-dealer
exclusion. Such broker-dealers may
respond to this interpretation by
increasing the amount of limited
discretionary services or monitoring
services that they agree to provide to
their customers. Investors that have
established relationships with such
broker-dealers may benefit from more
efficient access to these services and
may demand these services from brokerdealers rather than becoming clients of
investment advisers. While additional
provision of these services by brokerdealers also raises the risk of regulatory
arbitrage because similar activities
Subject
Release No.
*
*
*
Commission Interpretation Regarding the Solely
Incidental Prong of the Broker-Dealer Exclusion
from the Definition of Investment Adviser.
IA–5249
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Frm 00373
List of Subjects in 17 CFR Part 276
Securities.
Amendments to the Code of Federal
Regulations
For the reasons set out above, the
Commission is amending title 17,
chapter II of the Code of Federal
Regulations as set forth below:
PART 276—INTERPRETATIVE
RELEASES RELATING TO THE
INVESTMENT ADVISERS ACT OF 1940
AND GENERAL RULES AND
REGULATIONS THEREUNDER
1. Part 276 is amended by adding
Release No. IA–5249 and the release
date of June 5, 2019, to the end of the
list of interpretive releases to read as
follows:
■
FR vol. and page
*
*
June 5, 2019 .................
*
*
[Insert FR Volume Number] FR [Insert FR Page
Number]
advisers, and other financial intermediaries that are
not required to register as investment advisers (such
as banks, trust companies, insurance companies,
commodity trading advisers, and municipal
advisors) may to a varying degree gain business at
these affected broker-dealers’ expense.
PO 00000
would be regulated under different
regimes, we believe this risk will be
mitigated by the adoption of rules that
enhance the standard of conduct that
applies to broker-dealer
recommendations.
Date
By the Commission.
81 To the extent this interpretation results in
altered compliance costs for standalone brokerdealers, non-affected standalone broker-dealers (i.e.,
those standalone broker-dealers that already are in
compliance with the solely incidental prong as we
have interpreted it), dual registrants, investment
33689
Fmt 4701
Sfmt 9990
Dated: June 5, 2019.
Vanessa A. Countryman,
Acting Secretary.
[FR Doc. 2019–12209 Filed 7–11–19; 8:45 am]
BILLING CODE 8011–01–P
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]]>Agencies
[Federal Register Volume 84, Number 134 (Friday, July 12, 2019)]
[Rules and Regulations]
[Pages 33681-33689]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-12209]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 276
[Release No. IA-5249]
Commission Interpretation Regarding the Solely Incidental Prong
of the Broker-Dealer Exclusion From the Definition of Investment
Adviser
AGENCY: Securities and Exchange Commission.
ACTION: Interpretation.
-----------------------------------------------------------------------
SUMMARY: The Securities and Exchange Commission (the ``SEC'' or the
``Commission'') is publishing an interpretation of a section of the
Investment Advisers Act of 1940 (the ``Advisers Act'' or the ``Act''),
which excludes from the definition of ``investment adviser'' any broker
or dealer that provides advisory services when such services are
``solely incidental'' to the conduct of the broker or dealer's business
and when such incidental advisory services are provided for no special
compensation.
DATES: Effective July 12, 2019.
FOR FURTHER INFORMATION CONTACT: James McGinnis, Senior Counsel,
Investment Adviser Regulation Office, at (202) 551-6787 or
[email protected]; and Benjamin Kalish, Attorney-Advisor, or
[[Page 33682]]
Parisa Haghshenas, Branch Chief, Chief Counsel's Office at (202) 551-
6825 or [email protected], Division of Investment Management, Securities
and Exchange Commission, 100 F Street NE, Washington, DC 20549-8549.
SUPPLEMENTARY INFORMATION: The Commission is publishing an
interpretation of the solely incidental prong of the broker-dealer
exclusion in section 202(a)(11)(C) of the Advisers Act [15 U.S.C.
80b].\1\
---------------------------------------------------------------------------
\1\ 15 U.S.C. 80b. Unless otherwise noted, when we refer to the
Advisers Act, or any paragraph of the Advisers Act, we are referring
to 15 U.S.C. 80b of the United States Code, at which the Advisers
Act is codified.
---------------------------------------------------------------------------
Table of Contents
I. Introduction
II. Interpretation and Application
A. Historical Context and Legislative History
B. Scope of the Solely Incidental Prong of the Broker-Dealer
Exclusion
C. Guidance on Applying the Interpretation of the Solely
Incidental Prong
III. Economic Considerations
A. Background
B. Potential Economic Effects
I. Introduction
The Advisers Act regulates the activities of certain ``investment
advisers,'' who are defined in section 202(a)(11) of the Advisers Act
in part as persons who, for compensation, engage in the business of
advising others about securities. Section 202(a)(11)(C) excludes from
the definition of investment adviser--and thus from the application of
the Advisers Act--a broker or dealer ``whose performance of such
advisory services is solely incidental to the conduct of his business
as a broker or dealer and who receives no special compensation'' for
those services (the ``broker-dealer exclusion''). The broker-dealer
exclusion shows, on the one hand, that at the time the Advisers Act was
enacted Congress recognized broker-dealers commonly provided some
investment advice to their customers in the course of their business as
broker-dealers and that it would be inappropriate to bring broker-
dealers within the scope of the Advisers Act because of this aspect of
their business.\2\ On the other hand, the limitations of the exclusion
show that Congress excluded broker-dealer advisory services from the
scope of the Advisers Act only under certain circumstances--namely,
when those services are solely incidental to the broker-dealer's
regular business as a broker-dealer (the ``solely incidental prong'')
and when the broker-dealer receives no special compensation (the
``special compensation prong'').\3\
---------------------------------------------------------------------------
\2\ Opinion of 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) (``Advisers Act Release No. 2'').
\3\ See Regulation Best Interest, Securities Exchange Act
Release No. 83062 (April 18, 2018) [83 FR 21574 (May 9, 2018)]
(``Reg. BI Proposal''), at n.343. The broker-dealer exclusion is
conjunctive--that is, the broker-dealer must both provide investment
advice that is solely incidental to the conduct of his business as a
broker-dealer and the broker-dealer must receive no special
compensation. In the event that a broker-dealer's investment advice
fits within the guidance of this Release with respect to the solely
incidental prong, that broker-dealer must also receive no special
compensation for the advisory service to be consistent with the
broker-dealer exclusion.
---------------------------------------------------------------------------
On April 18, 2018, the Commission proposed a rulemaking intended to
enhance the standard of conduct for broker-dealers when providing
recommendations.\4\ The Commission also proposed an interpretation
intended to reaffirm and in some cases clarify the standard of conduct
for investment advisers,\5\ as well as a rulemaking intended to provide
retail investors with clear and succinct information regarding key
aspects of their brokerage and advisory relationships.\6\ The Reg. BI
Proposal discussed the broker-dealer exclusion and requested comment on
the scope of the exclusion as applied to a broker-dealer's exercise of
investment discretion.\7\ While some commenters addressed when a
broker-dealer's advisory services are ``solely incidental to the
conduct of his business as a broker or dealer'' in the context of the
exercise of investment discretion, more commenters addressed this prong
more generally.\8\ For example, many commenters requested general
guidance on or expressed views about the meaning of the solely
incidental prong \9\ and the permissibility under this prong of various
broker-dealer activities that relate to the investment advice they
provide in light of the Reg. BI Proposal and the Relationship Summary
Proposal.\10\ Other commenters suggested that our approach to the Reg.
BI Proposal was inconsistent with the solely incidental prong of the
broker-dealer exclusion. One commenter suggested that the Reg. BI
Proposal, if adopted, would allow broker-dealers to provide investment
advice beyond what the solely incidental prong should ``reasonably be
interpreted to permit,'' arguing that to qualify for exclusion from
regulation under the Advisers Act, broker-dealers should only ``be able
to provide very limited advice. . . .'' \11\ Two commenters thought
that the Commission's expressed support for maintaining the ``broker-
dealer model as an option for retail customers seeking investment
advice'' \12\ was inconsistent with the solely incidental prong.\13\
[[Page 33683]]
Another commenter called the Commission's previously articulated
interpretation of the solely incidental prong ``vague.'' \14\ The
comments we received demonstrate that there is disagreement about when
the provision of broker-dealer investment advice is consistent with the
solely incidental prong.\15\ In light of these comments, we are
adopting this interpretation to confirm and clarify the Commission's
position with respect to the solely incidental prong. To illustrate how
the interpretation functions, we discuss its application to two
advisory services that a broker or dealer may provide, namely: (i)
Exercising investment discretion over customer accounts and (ii)
account monitoring.\16\ Our interpretation complements each of the
rules and forms we are adopting, which, among other things, are
intended individually and collectively to enhance investor
understanding of the relationships and services offered by investment
advisers and broker-dealers.\17\
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\4\ See id.
\5\ Proposed Commission Interpretation Regarding Standard of
Conduct for Investment Advisers; Request for Comment on Enhancing
Investment Adviser Regulation, Investment Advisers Act Release No.
4889 (April 18, 2018) [83 FR 21203 (May 9, 2018)] (the ``Proposed
Fiduciary Interpretation'').
\6\ See Form CRS Relationship Summary; Amendments to Form ADV;
Required Disclosures in Retail Communications and Restrictions on
the Use of Certain Names or Titles, Investment Advisers Act Release
No. 4888 (April 18, 2018) [83 FR 21416 (May 9, 2018)]
(``Relationship Summary Proposal''). Concurrently with this
interpretation, we also are adopting the final versions of the rules
and interpretations proposed in the Relationship Summary Proposal,
the Reg. BI Proposal, and the Proposed Fiduciary Interpretation. See
Form CRS Relationship Summary; Amendments to Form ADV, Investment
Advisers Act Release No. 5247 (June 5, 2019) (the ``Relationship
Summary Adoption''); Regulation Best Interest: The Broker-Dealer
Standard of Conduct, Exchange Act Release No. 86031 (June 5, 2019)
(``Reg. BI Adoption''); and Commission Interpretation Regarding
Standard of Conduct for Investment Advisers, Investment Advisers Act
Release No. 5248 (June 5, 2019) (``Final Fiduciary
Interpretation'').
\7\ See Reg. BI Proposal, supra footnote 3, at nn.342-67 and
accompanying text.
\8\ We considered comments submitted in File No. S7-07-18 (Reg.
BI Proposal, supra footnote 3); File No. S7-08-18 (Relationship
Summary Proposal, supra footnote 6); and File No. S7-09-18 (Proposed
Fiduciary Interpretation, supra footnote 5). Those comments are
available on the Commission's website at https://www.sec.gov/comments/s7-07-18/s70718.htm, https://www.sec.gov/comments/s7-08-18/s70818.htm, and https://www.sec.gov/comments/s7-09-18/s70918.htm,
respectively.
\9\ See, e.g., Comment Letter of North American Securities
Administrators Association, Inc. (Aug. 23, 2018) (``NASAA Letter'');
Comment Letter of CFA Institute (Aug. 7, 2018) (``CFA Institute
Letter'') (noting the ``need to give guidance'' on the broker-dealer
exclusion and noting that the Commission has legal authority to
provide needed clarification); Comment Letter of the Institute for
the Fiduciary Standard (Aug. 6, 2018) (``IFS Letter'') (arguing that
when a broker's investment advice is solely incidental to its
business is one of a number of ``questions the SEC should
address''); Comment Letter of the Consumer Federation of America
(Aug. 7, 2018) (``CFA Letter'') (arguing that the Commission failed
to ``engage'' on ``just how far the `solely incidental' exclusion
stretches''); Comment Letter of the Investment Adviser Association
(Aug. 6, 2018) (``IAA Letter'') (``[T]he Commission should
reconsider when broker-dealers should be able to rely on the Solely
Incidental [prong].''); Comment Letter of Michael Kitces (Aug. 2,
2018) (``Kitces Letter'') (arguing that the Commission's prior
interpretations of the solely incidental prong are inconsistent with
the plain meaning and legislative history of the term).
\10\ See, e.g., CFA Letter; Kitces Letter.
\11\ See NASAA Letter.
\12\ See Reg. BI Proposal, supra footnote 3, at text
accompanying n.31.
\13\ See CFA Letter (stating that certain aspects of the
Relationship Summary Proposal and the Reg. BI Proposal indicated
that broker-dealers were in an ``advice relationship'' in a manner
that does not ``remotely sound like advice that is `solely
incidental to' the conduct of their business as a broker or
dealer''); Kitces Letter (arguing that referring to the broker-
dealer model as a ``model for advice'' is in contravention of the
broker-dealer exclusion because ``advice can only be incidental if
it occurs by chance, as a consequence of a product sale, or without
intent to give advice'').
\14\ See Comment Letter of Securities Arbitration Clinic, St.
Vincent DePaul Legal Program, Inc., St. John's University School of
Law (Aug. 7, 2018) (``St. John's Clinic Letter'').
\15\ Furthermore, interested parties have for years expressed
their views to the Commission on what they believe the broker-dealer
exclusion requires, including disagreements with the Commission's
interpretation of the exclusion. See, e.g., Comment Letter of
Consumer Federation of America (Sept. 20, 2004) (arguing that the
Commission should ``define `solely incidental' in a way that hews
closely to what commenters described as Congress's clear intent to
provide only a very narrow exclusion''), available at https://www.sec.gov/rules/proposed/s72599/s72599-1101.pdf.
\16\ We received comments requesting guidance with respect to
the solely incidental prong on both activities. See infra section
II.C.
\17\ See Reg. BI Adoption; Relationship Summary Adoption; Final
Fiduciary Interpretation, supra footnote 6. We also received a few
comments in response to the Reg. BI Proposal and the Relationship
Summary Proposal requesting that the Commission provide guidance on
the special compensation prong. See, e.g., CFA Letter (arguing,
among other points, that special compensation would constitute any
compensation other than commissions for trade execution); Comment
Letter of Coalition of Mutual Fund Investors (Aug. 8, 2018)
(``Mutual Fund Investors Letter'') (arguing that special
compensation should include all asset-based compensation and third-
party fees from mutual funds and their advisers). We are not
providing guidance on the special compensation prong in this Release
as we do not believe our views on this prong require additional
clarification. The Commission has considered the meaning of the
special compensation prong on previous occasions. See, e.g.,
Interpretive Rule Under the Advisers Act Affecting Broker-Dealers,
Investment Advisers Act Release No. 2652 (Sept. 24, 2007) (``2007
Proposing Release''); Certain Broker-Dealers Deemed Not to Be
Investment Advisers, Investment Advisers Act Release No. 2376 (Apr.
12, 2005) (``2005 Adopting Release,'' in which, as discussed infra
at footnote 38 and accompanying text, the Commission adopted a rule
that a court vacated on grounds that did not address our
interpretive positions relating to the solely incidental prong). The
comments we received in response to requests for comment to the Reg.
BI Proposal and the Relationship Summary Proposal did not
demonstrate that there is significant disagreement with our
interpretation of that prong.
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II. Interpretation and Application
A. Historical Context and Legislative History
When the Advisers Act was enacted in 1940, broker-dealers regularly
provided investment advice.\18\ They did so in two distinct ways: As an
auxiliary part of 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.\19\ 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.\20\ ``Brokerage house advice'' was extensive and varied,\21\ and
included information about various corporations, municipalities, and
governments; \22\ broad analyses of general business and financial
conditions; \23\ market letters and special analyses of companies'
situations; \24\ information about income tax schedules and tax
consequences; \25\ and ``chart reading.'' \26\ 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 firms whose sole
business was providing ``investment counsel'' services.\27\
---------------------------------------------------------------------------
\18\ For an extensive discussion of broker-dealer practice in
the years leading up to enactment of the Advisers Act, from which
this summary is drawn, see 2005 Adopting Release, supra footnote 17;
Certain Broker-Dealers Deemed Not to Be Investment Advisers,
Investment Advisers Act Release No. 2340 (Jan. 6, 2005) (``2005
Proposing Release'').
\19\ 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.'').
\20\ See Twentieth Century Fund, The Security Markets (1935)
(``Security Markets'') at 633-46 (discussing ``brokerage house
advice''); see also Charles F. Hodges, Wall Street (1930) (``Wall
Street'') at 253-85; SEC, Report on Investment Counsel, Investment
Management, Investment Supervisory, and Investment Advisory Services
(1939) (H.R. Doc. No. 477) (``Investment Counsel Report'') at n.1.
\21\ See, e.g., Report of Public Examining Bd. on Customer
Protection to N.Y. Stock Exchange (Aug. 31, 1939), at 3: 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.
\22\ Security Markets, supra footnote 20, at 633; Wall Street,
supra footnote 20, 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.'').
\23\ Security Markets, supra footnote 20, at 634; Wall Street,
supra footnote 20, at 254.
\24\ Security Markets, supra footnote 20, at 640-43; Wall
Street, supra footnote 20, at 277-85.
\25\ Security Markets, supra footnote 20, at 641.
\26\ 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'').
\27\ See Advisers Act Release No. 2, supra footnote 2; see also
Security Markets, supra footnote 20, 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 Advisers Act, ``investment counsel'' is a
defined subset of the ``investment advisers'' to whom the Act
applies. See section 208(c) of the Act.
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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, including
broker-dealers with investment advisory departments.\28\ 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
[[Page 33684]]
institutions.'' \29\ 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 persons engaged in the business of providing
investment advice for compensation.
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\28\ Investment Counsel Report, supra footnote 20, 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]; see Hearings on S.
3580, supra footnote 19, at 995-96.
\29\ Investment Counsel Report, supra footnote 20, at 27.
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Congress responded 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 \30\ should be free from any oversight
except, perhaps, by the few states that had passed laws regulating
investment counselors and by private organizations, such as the
Investment Counsel Association of America.\31\ 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.\32\
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\30\ Hearings on S. 3580, supra footnote 19, at 745-48; see also
2005 Adopting Release, supra footnote 17, at n.62.
\31\ Hearings on S. 3580, supra footnote 19, at 716-18, 736-38,
740-41, 744-45, 760, 763.
\32\ Id. 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 SEC. 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. Id. at 995-96. Eventually,
members of the investment counsel industry agreed with the proposed
legislation. See id. at 1124; 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.
(1940) (``Hearings on H.R. 10065''); see also S. Rep. No. 76-1775,
76th Cong., 3d Sess. 21 (1940); H.R. Rep. No. 76-2639, 76th Cong.,
3d Sess. 27 (1940).
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Conversely, the Advisers Act specifically excluded persons, among
others, from the broad definition of ``investment adviser'' to the
extent that such persons rendered investment advice incidental to their
primary business.\33\ Broker-dealers were among these excluded persons,
as section 202(a)(11)(C) of the Act excludes 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''--i.e.,
the broker-dealer exclusion.
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\33\ The exclusion for certain professionals in Advisers Act
section 202(a)(11) 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) reprinted in
Hearings on S. 3580, supra footnote 19, at 1007. That report stated
that ``the investment advice furnished by these excepted groups
would seem to be merely incidental to some other function being
performed by them.'' Id.
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B. Scope of the Solely Incidental Prong of the Broker-Dealer Exclusion
The Commission and its staff have on several occasions discussed
the scope of the broker-dealer exclusion.\34\ In adopting a rule
regarding fee-based brokerage accounts in 2005, for example, the
Commission stated that investment advisory services are ``solely
incidental to'' the conduct of a broker-dealer's business when the
services are offered in connection with and are reasonably related to
the brokerage services provided to an account.\35\ The interpretation
was consistent with the Commission's contemporaneous construction of
the Advisers Act as excluding broker-dealers whose investment advice is
given ``solely as an incident of their regular business.'' \36\ The
2005 interpretation stated that the importance or frequency of the
investment advice was not a determinant of whether the solely
incidental prong was satisfied; the Commission rejected the view that
only minor, insignificant, or infrequent advice qualifies for the
broker-dealer exclusion, noting that the advice broker-dealers gave as
part of their brokerage services in 1940 was often substantial and
important to customers.\37\
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\34\ See, e.g., Advisers Act Release No. 2, supra footnote 2;
Applicability of the Investment Advisers Act to Certain Brokers and
Dealers; Interpretation of the Term `Special Compensation',
Investment Advisers Act Release No. 640 (Oct. 5, 1978);
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).
\35\ 2005 Adopting Release, supra footnote 17; 2005 Proposing
Release, supra footnote 18.
\36\ See Advisers Act Release No. 2, supra footnote 2; see also
2005 Adopting Release, supra footnote 17.
\37\ See 2005 Adopting Release, supra footnote 17, at nn.139-42
and accompanying text.
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On March 30, 2007, the Court of Appeals for the District of
Columbia Circuit in Financial Planning Association v. SEC vacated the
rule regarding fee-based brokerage accounts, but not on grounds that
addressed our interpretive positions relating to the solely incidental
prong.\38\ In September 2007, we proposed to reinstate these
interpretive positions.\39\
---------------------------------------------------------------------------
\38\ See 482 F.3d 481 (D.C. Cir. 2007).
\39\ 2007 Proposing Release, supra footnote 17.
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Since that time, a federal appellate court has addressed the solely
incidental prong. In 2011, in Thomas v. Metropolitan Life Insurance
Company, the Court of Appeals for the Tenth Circuit addressed the scope
of the broker-dealer exclusion in the context of a private suit
alleging that a broker had violated the Advisers Act by failing to
disclose incentives to sell proprietary products.\40\ As part of its
analysis of the exclusion, the court looked to the interpretation of
the solely incidental prong that we advanced in 2005 and 2007. The
court found these interpretations to be ``persuasive'' in light of its
own analysis of the text of the solely incidental prong of the broker-
dealer exclusion as well as the legislative history and historical
background of the Advisers Act.\41\ The court concluded that a broker-
dealer's investment advice is solely incidental to its conduct as a
broker-dealer if the advice is given ``only in connection with the
primary business of selling securities.'' \42\ Thus, the court
explained, ``broker-dealers who give advice that is not connected to
the sale of securities--or whose primary business consists of giving
advice--do not meet the [solely incidental] prong'' of the broker-
dealer exclusion.\43\ The court also agreed with the Commission's
interpretations that the solely incidental prong does not
[[Page 33685]]
hinge upon ``the quantum or importance'' of a broker-dealer's advice
but on its relationship to the broker-dealer's primary business.\44\ In
the court's view, ``[t]he quantum or importance of the broker-dealer's
advice is relevant only insofar as the advice cannot supersede the sale
of the product as the `primary' goal of the transaction or the
`primary' business of the broker-dealer.'' \45\
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\40\ 631 F.3d 1153 (10th Cir. 2011).
\41\ Id. at 1163-64.
\42\ Id. at 1164.
\43\ Id.
\44\ Id. at 1163.
\45\ Id. at 1166. In Thomas, the brokerage firm's representative
had conducted an analysis of the plaintiffs' financial situation and
advised them to purchase a particular financial product based in
part on that analysis. The plaintiffs alleged that the firm's policy
``required [representatives] to provide investment advice to
potential customers as a means to sell more proprietary products''
and that this policy was ``so pervasive that [representatives]
allegedly gave financial advice to every customer to whom they sold
a product.'' Id. at 1157. The Court rejected the plaintiffs'
contention that these facts rendered the advice so central to the
transaction that it could not be considered ``solely incidental'' to
it. Because the representative's advice ``was closely related to the
sale of the [product] and selling the [product] was the primary
object of the transaction,'' the Court concluded, the advice was
``solely incidental'' to the representative's conduct as a broker.
Id. at 1167.
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Based on the text and history of the solely incidental prong, our
previous interpretations of the prong, the Thomas decision, and the
comments we have received, we are providing the following
interpretation.\46\ We interpret the statutory language to mean that a
broker-dealer's provision of advice as to the value and characteristics
of securities or as to the advisability of transacting in securities
\47\ is consistent with the solely incidental prong if the advice is
provided in connection with and is reasonably related to the broker-
dealer's primary business of effecting securities transactions.\48\ If
a broker-dealer's primary business is giving advice as to the value and
characteristics of securities or the advisability of transacting in
securities, or if the advisory services are not offered in connection
with or are not reasonably related to the broker-dealer's business of
effecting securities transactions, the broker-dealer's advisory
services are not solely incidental to its business as a broker-
dealer.\49\ Whether advisory services provided by a broker-dealer
satisfy the solely incidental prong is assessed based on the facts and
circumstances surrounding the broker-dealer's business, the specific
services offered, and the relationship between the broker-dealer and
the customer.
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\46\ To the extent that this interpretation is inconsistent with
the Commission's prior interpretations with respect to the solely
incidental prong, this interpretation supersedes those
interpretations.
\47\ See Advisers Act section 202(a)(11) (definition of
``investment adviser'').
\48\ Cf. 2005 Adopting Release, supra footnote 17 (``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 . . . when the advisory
services rendered are in connection with and reasonably related to
the brokerage services provided.''). We have modified the wording of
our interpretation to make clear that the broker-dealer's primary
business must also be effecting securities transactions.
\49\ Nothing in this interpretation alters the Commission's 2006
interpretation of section 28(e) of the Exchange Act, which, in the
context of a client commission arrangement that otherwise satisfies
section 28(e), permits a broker-dealer to be paid out of a pool of
commissions for its research even if that broker-dealer did not
effect a securities transaction. See Commission Guidance Regarding
Client Commission Practices Under Section 28(e) of the Securities
Exchange Act of 1934, Securities Exchange Act Release No. 54165
(July 18, 2006), 71 FR 41978 (July 24, 2006).
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The quantum or importance of investment advice that a broker-dealer
provides to a client is not determinative as to whether or not the
provision of advice is consistent with the solely incidental prong.
Advice need not be trivial, inconsequential, or infrequent to be
consistent with the solely incidental prong. Indeed, our simultaneous
adoption of (i) Regulation Best Interest, which raises the standard of
conduct that applies to broker-dealer recommendations, and (ii) the
relationship summary, which provides information about broker-dealer
recommendation services to customers, underscores that broker-dealer
investment advice can be consequential even when it is offered in
connection with and reasonably related to the primary business of
effecting securities transactions.
To illustrate the application of this interpretation in practice,
we provide the following guidance on the application of the
interpretation to (i) exercising investment discretion over customer
accounts and (ii) account monitoring.
C. Guidance on Applying the Interpretation of the Solely Incidental
Prong
1. Investment Discretion
The Commission has for many years considered issues related to a
broker-dealer's exercise of investment discretion over customer
accounts and the extent to which such practices could be considered
solely incidental to the business of a broker-dealer.\50\ The
Commission has stated that discretionary brokerage relationships ``have
many of the characteristics of the relationships to which the
protections of the Advisers Act are important.'' \51\ In particular,
the Commission has explained that when a broker-dealer exercises
investment discretion, it is not providing advice to customers that is
in connection with and reasonably related to effecting securities
transactions; rather, the broker-dealer is making investment decisions
relating to the purchase or sale of securities on behalf of customers
on an ongoing basis.\52\ At the same time, the Commission has taken the
position that some limited exercise of discretionary authority by
broker-dealers could be considered solely incidental to their
business.\53\
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\50\ See Reg. BI Proposal, supra footnote 3, at nn.343-62 and
accompanying text.
\51\ Final Extension of Temporary Exemption from the Investment
Advisers Act for Certain Brokers and Dealers, Investment Advisers
Act Release No. 626 (Apr. 27, 1978) (``Advisers Act Release No.
626'').
\52\ See 2005 Proposing Release, supra footnote 18.
\53\ See Reg. BI Proposal, supra footnote 3, at nn.355-62 and
accompanying text. Cf. NASD rule 2510 (allowing discretion only if a
customer ``has given prior written authorization to a stated
individual or individuals . . . in accordance with [FINRA] rule
3010'').
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We requested comment in the Reg. BI Proposal on a broker-dealer's
exercise of investment discretion over customer accounts and the extent
to which the exercise of investment discretion should be considered
solely incidental to the business of a broker-dealer.\54\ Commenters
agreed that the exercise of unlimited discretion should not be
considered ``solely incidental'' investment advice.\55\ Commenters
expressed varying views, however, on the extent to which the exercise
of temporary or limited discretion could be considered solely
incidental to the business of a broker-dealer. Several commenters
suggested that the exercise of any investment discretion should be
governed by the Advisers Act.\56\ One commenter suggested that the
Commission should interpret the solely incidental prong through the
lens of the definition of ``investment discretion'' in section 3(a)(35)
of the Securities Exchange Act of 1934 (the ``Exchange Act''),\57\
noting that section 3(a)(35)
[[Page 33686]]
focuses on ``the level of authority, decision-making ability,
influence--and ultimately, control--an intermediary has over another's
money'' and arguing that those with section 3(a)(35) investment
discretion have a heightened likelihood of mismanagement and abuse of
another's money.\58\ Another commenter suggested that, while discretion
generally should subject a broker-dealer to the Advisers Act, there are
certain cases where temporary or limited discretion does not have the
supervisory or managerial character of the investment discretion
warranting the protections of the Advisers Act.\59\
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\54\ See Relationship Summary Proposal, supra footnote 6, at
nn.363-67 and accompanying text; see also id. at nn.343-62 and
accompanying text for a description of the Commission's historical
approaches.
\55\ See, e.g., Comment Letter of Financial Planning Coalition
(Aug. 7, 2018) (``FPC Letter'') (``[A] broker-dealer's provision of
unfettered discretionary investment advice should never be
considered `solely incidental' to its business as a broker-dealer.''
(emphasis removed)); CFA Letter; IFS Letter.
\56\ See, e.g., Comment Letter of Invesco Advisers, Inc. (Aug.
7, 2018) (``Discretionary management over an account, whether or not
temporary, is not within the scope of the `solely incidental'
exclusion.''); IAA Letter; CFA Institute Letter.
\57\ Under Exchange Act section 3(a)(35), 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
though 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. 15 U.S.C. 78c(a)(35).
\58\ See FPC Letter (noting also that several federal and state
courts have used factors similar to those in section 3(a)(35) to
impose a fiduciary standard). Another commenter also suggested using
Exchange Act section 3(a)(35) ``investment discretion'' as a basis
for establishing whether discretion is not solely incidental for
purposes of the broker-dealer exclusion, with an exception for
investment discretion ``that a customer grants on a temporary or
limited basis.'' See Comment Letter of Pickard Djinis and Pisarri
(Aug. 14, 2018) (``Pickard Letter'').
\59\ See Comment Letter of the Securities Industry and Financial
Markets Association (Aug. 7, 2018) (``SIFMA Letter'').
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Applying our interpretation of the solely incidental prong, a
broker-dealer's exercise of unlimited discretion \60\ would not be
solely incidental to the business of a broker-dealer consistent with
the meaning of section 202(a)(11)(C).\61\ It would be inconsistent with
the solely incidental prong for broker-dealers to exercise ``investment
discretion'' as that term is defined in section 3(a)(35) of the
Exchange Act with respect to any of its accounts, except for certain
instances of investment discretion granted by a customer on a temporary
or limited basis, as discussed below. A broker-dealer with unlimited
discretion to effect securities transactions possesses ongoing
authority over the customer's account indicating a relationship that is
primarily advisory in nature; such a level of discretion by a broker-
dealer is so comprehensive and continuous that the provision of advice
in such context is not incidental to effecting securities transactions.
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\60\ We view unlimited investment discretion as a person having
the ability or authority to buy and sell securities on behalf of a
customer without consulting the customer--i.e., having
responsibility for a customer's trading decisions.
\61\ The Commission has in the past stated that the
quintessentially supervisory or managerial character of investment
discretion warrants the protection of the Advisers Act. See
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); see also 2005 Proposing
Release, supra footnote 18; 2005 Adopting Release, supra footnote
17.
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We recognize, however, that there are situations where a broker-
dealer may exercise temporary or limited discretion in a way that is
not indicative of a relationship that is primarily advisory in nature.
Generally, these are situations where the discretion is limited in
time, scope, or other manner and lacks the comprehensive and continuous
character of investment discretion that would suggest that the
relationship is primarily advisory. The totality of the facts and
circumstances would be relevant to determining whether temporary or
limited discretion is consistent with the solely incidental prong.
Taking into consideration specific examples that commenters have
suggested in the past, instances of temporary or limited investment
discretion that, standing alone, would not support the conclusion that
a relationship is primarily advisory--and therefore outside the scope
of the solely incidental prong--include discretion: (i) 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; (ii) 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; (iii) as to cash management, such as to
exchange a position in a money market fund for another money market
fund or cash equivalent; \62\ (iv) to purchase or sell securities to
satisfy margin requirements, or other customer obligations that the
customer has specified; (v) to sell specific bonds or other securities
and purchase similar bonds or other securities in order to permit a
customer to realize a tax loss on the original position; (vi) to
purchase a bond with a specified credit rating and maturity; and (vii)
to purchase or sell a security or type of security limited by specific
parameters established by the customer. We view these examples of
temporary or limited discretion as typically consistent with the
broker-dealer exclusion because they are in connection with and
reasonably related to a broker-dealer's business of effecting
securities transactions and do not suggest that the broker-dealer's
primary business is providing investment advice.
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\62\ Certain changes to money market fund regulation and
operations have been implemented since our prior interpretations.
See Money Market Fund Reform; Amendments to Form PF, Investment
Company Act Release No. 31166 (Jul. 23, 2014) (removing an exemption
that permitted institutional non-government money market funds to
maintain a stable net asset value, while maintaining such exemption
for certain other money market funds, and applying certain fees and
gates reforms to institutional non-government money market funds and
retail money market funds but not to government money market funds,
among other changes). In light of these changes, differently
categorized money market funds may have different investment
characteristics. Accordingly, we anticipate that FINRA will be
reviewing the application of the rules that apply to the exercise of
broker-dealer discretion in this context. The Commission staff also
will evaluate broker-dealer exercise of discretionary cash
management to consider whether additional measures may be necessary.
---------------------------------------------------------------------------
We have previously described a similar list of situations that we
would consider temporary or limited discretion that may be consistent
with the solely incidental prong.\63\ We make three refinements.
---------------------------------------------------------------------------
\63\ See 2005 Adopting Release, supra footnote 17, at nn.178-81
and accompanying text; 2007 Proposing Release, supra footnote 17, at
n.13 and accompanying text.
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First, we are not including authority for a period ``not to exceed
a few months'' relating to the time a broker-dealer may purchase or
sell a security or type of security when a customer is unavailable for
a limited period of time. Depending on the facts and circumstances, a
period of discretion lasting a few months may be indicative of a
business or customer relationship that is primarily advisory in nature.
Second, we would view it as consistent with our interpretation of
the solely incidental prong for broker-dealers to purchase or sell
securities to satisfy margin requirements, or other customer
obligations that the customer has specified (new wording italicized).
In our view, there may be similar obligations to a broker-dealer or a
third party whereby a broker-dealer may be authorized to make a
purchase or sale, such as a sale to satisfy a collateral call.
Third, we would view it as consistent with our interpretation of
the solely incidental prong for broker-dealers to sell specific bonds
or other securities in order to permit a customer to realize a tax loss
on the original position (new wording italicized). We see no
distinction between bonds or other securities in this particular
context.
2. Account Monitoring
We received several comments regarding the extent to which a
broker-dealer may monitor the status and
[[Page 33687]]
performance of a customer's account while relying on the broker-dealer
exclusion. Some commenters suggested that a broker-dealer's agreement
to provide ongoing monitoring for the purpose of recommending changes
to a customer's investments is not an advisory service that is solely
incidental to the primary securities transaction business of a broker-
dealer and thus the broker-dealer exclusion should not be available to
broker-dealers who provide such services.\64\ Another commenter
suggested that broker-dealers providing personalized investment advice
about securities on an ongoing basis should not be able to rely on the
broker-dealer exclusion.\65\ Commenters also suggested that providing
services that cause overseen assets to meet the definition of
``regulatory assets under management'' under Form ADV (i.e., securities
portfolios for which the broker-dealer provides ``continuous and
regular supervisory or management services'') should subject a broker-
dealer to the Advisers Act.\66\
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\64\ See FPC Letter (``[B]roker-dealers that enter into
agreements with retail customers to provide ongoing monitoring for
purposes of recommending changes in investments should be considered
investment advisers and subject to fiduciary obligations under the
Advisers Act. Entering into an agreement to provide ongoing
monitoring. . . goes beyond advice that is solely incidental to the
conduct of business as a broker-dealer. . . .''); IAA Letter (same
quotation as the FPC Letter); IAA Letter (``[A] broker-dealer that
agrees to provide a retail customer ongoing monitoring for purposes
of recommending changes in investments would not be providing
services that are solely incidental to its business as a broker-
dealer under the 2007 interpretation.''); Fisher Letter (``Brokers
can give ongoing investment advice . . . yet still not be required
to register as an investment adviser. . . . [T]he boundaries
[between brokers and investment advisers] have practically been
erased.'').
\65\ See Mutual Fund Investors Letter (``[The SEC] should . . .
subject broker-dealers to the Advisers Act when they are providing
personalized investment advice about securities on an ongoing basis
. . . The term `solely incidental' should be interpreted narrowly
and only include personalized investment advice that is one-time,
temporary, or limited in scope.'').
\66\ See IAA Letter; Pickard Letter.
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We disagree with commenters who suggested that any monitoring of
customer accounts would not be consistent with the solely incidental
prong. A broker-dealer that agrees to monitor \67\ a retail customer's
account on a periodic basis for purposes of providing buy, sell, or
hold recommendations may still be considered to provide advice in
connection with and reasonably related to effecting securities
transactions.\68\ In contrast, when a broker-dealer, voluntarily and
without any agreement with the customer, reviews the holdings in a
retail customer's account for the purposes of determining whether to
provide a recommendation to the customer--and, if applicable, contacts
that customer to provide a recommendation based on that voluntary
review--the broker-dealer's actions are in connection with and
reasonably related to the broker-dealer's primary business of effecting
securities transactions. Absent an agreement with the customer (which
would be required to be disclosed pursuant to Regulation Best
Interest), we do not consider this voluntary review to be ``account
monitoring.'' \69\
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\67\ The guidance in this section applies when a broker-dealer
agrees to monitor a customer's account. See Reg. BI Adoption, supra
footnote 6, at section II.B.2 for a discussion of what constitutes
such an agreement.
\68\ See id. Monitoring agreed to by the broker-dealer would
result in a recommendation to purchase, sell, or hold a security
each time the agreed-to monitoring occurs and would be covered by
Regulation Best Interest. See id. (``For example, if a broker-dealer
agrees to monitor the retail customer's account on a quarterly
basis, the quarterly review and each resulting recommendation to
purchase, sell, or hold, will be a recommendation subject to
Regulation Best Interest.'').
In agreeing to provide any monitoring services, broker-dealers
should also consider that a broker-dealer that separately contracts
or charges a separate fee for advisory services is providing
investment advice that is inconsistent with the broker-dealer
exclusion. See, e.g., 2005 Adopting Release, supra footnote 17.
Broker-dealers should also consider that, even where such monitoring
is consistent with the solely incidental prong, the broker-dealer
must also receive no special compensation for the activity to be
eligible for the broker-dealer exclusion. Broker-dealers receive
special compensation where there is a clearly definable charge for
investment advice. See Advisers Act Release No. 626, supra footnote
51; see also Advisers Act Release No. 2, supra footnote 2; 2007
Proposing Release, supra footnote 17 (describing this interpretation
as the Commission's ``longstanding view'').
\69\ See Reg. BI Adoption, supra footnote 6, at section
II.B.2.b. Any recommendation made to the retail customer as a result
of such voluntary review would be subject to Regulation Best
Interest. See id.
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We decline to delineate every circumstance where agreed-upon
monitoring is and is not solely incidental to a broker-dealer's
brokerage business. Broker-dealers may consider adopting policies and
procedures that, if followed, would help demonstrate that any agreed-
upon monitoring is in connection with and reasonably related to the
broker-dealer's primary business of effecting securities transactions.
For example, broker-dealers may include in their policies and
procedures that a registered representative may agree to monitor a
customer's account at specific time frames (e.g., quarterly) for the
purpose of determining whether to provide a buy, sell, or hold
recommendation to the customer.\70\ However, such policies and
procedures should not permit a broker-dealer to agree to monitor a
customer account in a manner that in effect results in the provision of
advisory services that are not in connection with or reasonably related
to the broker-dealer's primary business of effecting securities
transactions, such as providing continuous monitoring.\71\
Additionally, dually registered firms may similarly consider adopting
policies and procedures that distinguish the level and type of
monitoring in advisory and brokerage accounts.\72\
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\70\ As noted in the Reg. BI Adoption, and consistent with the
relationship summary adopted in the Relationship Summary Adoption,
the scope and frequency of a broker-dealer's monitoring is a
material fact relating to the type and scope of services provided to
a retail customer and thus is required to be disclosed under
Regulation Best Interest. See id. at section II.B.2; cf.
Relationship Summary Adoption, supra footnote 6. A broker-dealer
disclosing to a customer that the broker-dealer will provide
monitoring constitutes an agreement to monitor. See supra footnote
67.
\71\ The two examples of advisory services we discuss in this
Release--investment discretion and monitoring--cannot be viewed and
interpreted in isolation. For example, it would not be consistent
with the solely incidental prong for a broker-dealer to exercise
unlimited investment discretion over a customer account even if its
monitoring activities do comport with the solely incidental prong.
Thus, any policies and procedures that a broker-dealer adopts to
ensure that the broker-dealer's activities are in connection with
and reasonably related to the broker-dealer's primary business of
effecting securities transactions similarly should not grant the
broker-dealer the ability or authority to buy and sell securities on
behalf of a customer as part of periodic account monitoring, except
in circumstances of temporary or limited discretion that would be
consistent with the solely incidental prong, as discussed above.
\72\ In the Final Fiduciary Interpretation, we note that
investment advisers may consider whether written policies and
procedures relating to monitoring would be appropriate under
Advisers Act rule 206(4)-7. See Final Fiduciary Interpretation,
supra footnote 6, at section II.B.3.
Additionally, the Reg. BI Adoption confirms that a dual
registrant is an investment adviser solely with respect to those
accounts for which a dual registrant provides investment advice or
receives compensation that subjects it to the Advisers Act. See Reg.
BI Adoption, supra footnote 6, at section II.B.3.d. Determining the
capacity in which a dual registrant is making a recommendation is a
facts and circumstances test. See id.
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The Commission will consider further comment on its interpretation
of the solely incidental prong of the broker-dealer exclusion and its
application to certain brokerage activities to evaluate whether
additional guidance might be appropriate in the future. Based on any
comments received, the Commission may, but need not, supplement this
interpretation.
III. Economic Considerations
The Commission's interpretation above is intended to advise the
public of its understanding of the solely incidental prong of the
broker-dealer exclusion. The interpretation does not itself create any
new legal obligations for broker-dealers. Nonetheless, the
[[Page 33688]]
Commission recognizes that to the extent a broker-dealer's practices
are not consistent with this interpretation of the solely incidental
prong, the interpretation could have potential economic effects. We
discuss these effects below.
A. Background
The Commission's interpretation regarding the solely incidental
prong of the broker-dealer exclusion would affect broker-dealers and
their associated persons as well as the customers of those broker-
dealers, and the market for financial advice more broadly.\73\ As of
December 2018, there were approximately 3,764 registered broker-dealers
with over 140 million customer accounts. In total, these broker-dealers
have over $4.3 trillion in total assets, which are total broker-dealer
assets as reported on Form X-17a-5.\74\ Of the broker-dealers
registered with the Commission as of December 2018, 363 broker-dealers
were dually registered with the Commission as investment advisers.\75\
Dual registrant firms hold over 90 million (63%) of the overall 140
million customer accounts held by broker dealers.\76\ As part of the
Reg. BI Proposal, we requested data and other information related to
the nature and magnitude of discretionary services offered by broker-
dealers,\77\ but did not receive any data or information to inform our
analysis of potential economic effects stemming from this
interpretation.
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\73\ See Relationship Summary Adoption, supra footnote 6, at
section IV.B (discussing the market for financial advice generally).
\74\ Assets are estimated by Total Assets (allowable and non-
allowable) from Part II of the FOCUS filings (Form X-17A-5 Part II,
available at https://www.sec.gov/files/formx-17a-5_2.pdf) and
correspond to balance sheet total assets for the broker-dealer. The
Commission does not have an estimate of the total amount of customer
assets for broker-dealers. We estimate broker-dealer size from the
total balance sheet assets as described above.
\75\ For purposes of this analysis, a dual registrant is any
firm that is dually registered with the Commission as an investment
adviser and a broker-dealer. Because this number does not include
the number of broker-dealers who are also registered as state
investment advisers, the number undercounts the full number of
broker-dealers that operate in both capacities.
\76\ Some broker-dealers may be affiliated with investment
advisers without being dually registered. From Question 10 on Form
BD, 2,098 broker-dealers report that directly or indirectly, they
either control, are controlled by, or under common control with an
entity that is engaged in the securities or investment advisory
business. Comparatively, 2,691 (19.57%) SEC-registered investment
advisers report an affiliate that is a broker-dealer in Section 7A
of Schedule D of Form ADV, including 1,916 SEC-registered investment
advisers that report an affiliate that is a registered broker-
dealer. Approximately 74% of total assets under management of
investment advisers are managed by these 2,691 investment advisers.
\77\ See Reg. BI Proposal, supra footnote 3.
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B. Potential Economic Effects
Broker-dealers currently incur ongoing costs related to compliance
with their legal and regulatory obligations, including costs related to
understanding their practices and structuring their practices to be
consistent with the solely incidental prong of the broker-dealer
exclusion. This interpretation generally confirms the scope of the
solely incidental prong of the broker-dealer exclusion.
Generally, we believe that few, if any, broker-dealers take the
view that they act consistently with the solely incidental prong with
respect to any accounts over which the broker-dealer exercises more
than temporary or limited investment discretion.\78\ As with other
circumstances in which the Commission speaks to the legal obligations
of regulated entities, we acknowledge that affected firms, including
those whose practices are consistent with the Commission's
interpretation, incur costs to evaluate the Commission's interpretation
and assess its applicability to them. Further, to the extent certain
broker-dealers currently understand the scope of permissible monitoring
or other permissible advisory activities under the solely incidental
prong to be different from what is set forth in this interpretation,
there could be some economic effects.\79\
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\78\ See Comment Letter of UBS (noting that broker-dealers have
existing arrangements where they exercise temporary or limited
discretion, such as discretion as to time and price, and that those
types of discretion ``do not present the sort of risks about which
the SEC is concerned with respect to the exercise of unfettered
discretion'') (emphasis added); SIFMA Letter (noting that there are
instances in which temporary or limited discretion, such as
discretion as to prices at which securities can be purchased, does
not have the supervisory or managerial character of the investment
discretion warranting the protections of the Advisers Act).
\79\ The above application of our interpretation of the solely
incidental prong to the exercise of investment discretion is
generally consistent with the position taken in the 2005 Adopting
Release and preliminarily taken in the 2007 Proposing Release. We
believe that many broker-dealers changed their practices with
respect to investment discretion in light of those releases, and
thus those practices likely are consistent with our interpretation
of the solely incidental prong.
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This interpretation may produce economic effects to the extent that
it causes any broker-dealers to recognize that their practices are
inconsistent with the solely incidental prong and to adjust their
practices to make them consistent. In particular, broker-dealers that
have interpreted the solely incidental prong to conduct more advisory
activities than this interpretation permits may choose to no longer
provide such services to customers. This could result in a loss of
certain customers, a reduction in certain business activities, and
could preclude those broker-dealers from further developing certain
services for their customers, except to the extent those broker-dealers
are dually registered firms and their customers are also advisory
clients. This may, in turn, result in decreased competition in the
market for certain services, increased fees for those services, or a
diminished number of broker-dealers offering commission-based services
to investors.\80\
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\80\ For example, to the extent that broker-dealers respond to
the interpretation by limiting the levels of discretion that they
provide for their customers, execution quality (including the
execution price) may be affected due to the delays encountered when
the broker-dealer must contact a customer to proceed with a
transaction.
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To the extent any broker-dealers have been providing advisory
services beyond the scope of this interpretation, their customers may
receive fewer advisory services if these broker-dealers choose not to
register as investment advisers and adjust their business practices in
light of this interpretation. To the extent that this interpretation
would lead to a decline in the supply of certain services offered by
broker-dealers (or a decline in broker-dealers offering services to
particular customers), it could reduce the efficiency of portfolio
construction for those investors who might otherwise benefit from
broker-dealers providing investment advice with respect to their
account and would find similar advice from investment advisers to be
too costly or unattainable (e.g., due to account minimum requirements).
For example, certain broker-dealers may incur costs to adopt or revise
policies and procedures to ensure that the account monitoring that they
may agree to provide their customers is consistent with this
interpretation and may choose instead to stop offering such monitoring
services. Further, to the extent that any broker-dealers determine that
their services are not consistent with this interpretation, they may
choose to register as investment advisers with the Commission, or one
or more states, as applicable. Such broker-dealers would bear costs in
choosing to register as investment advisers to continue providing those
services, and their clients may face higher fees as a result.
Alternatively, broker-dealers that have investment adviser affiliates
may seek to place existing customers in advisory accounts instead of
brokerage accounts.
Broker-dealers that determine they must change business practices
as a
[[Page 33689]]
result of this interpretation will choose their responses based on
their circumstances. For example, if broker-dealers with affiliated
advisers are able to utilize their existing regulatory infrastructure
and compliance policies and procedures to account for activities that
are inconsistent with the solely incidental exclusion they may face
lower costs associated with migration of brokerage accounts and
activities to investment advisory accounts. By contrast, we expect the
costs of regulatory registration and compliance to be greater for any
standalone broker-dealers that choose to become registered investment
advisers, as they are more likely to need to undertake new systems,
procedures, and policies.
To the extent that broker-dealers choose to discontinue providing
certain services, register as investment advisers, or encourage
migration of customer's brokerage accounts to advisory accounts of
affiliates, this interpretation could result in a shift in the demand
for the services of different types of financial service providers,
decreasing the demand for services of broker-dealers and increasing the
demand for the services of investment advisers.\81\
This interpretation may also produce some overall economic effects
to the extent that it causes any broker-dealers that to date have
avoided performing limited discretion and other activities to recognize
that they may perform such activities consistent with the solely
incidental prong of the broker-dealer exclusion. Such broker-dealers
may respond to this interpretation by increasing the amount of limited
discretionary services or monitoring services that they agree to
provide to their customers. Investors that have established
relationships with such broker-dealers may benefit from more efficient
access to these services and may demand these services from broker-
dealers rather than becoming clients of investment advisers. While
additional provision of these services by broker-dealers also raises
the risk of regulatory arbitrage because similar activities would be
regulated under different regimes, we believe this risk will be
mitigated by the adoption of rules that enhance the standard of conduct
that applies to broker-dealer recommendations.
List of Subjects in 17 CFR Part 276
Securities.
Amendments to the Code of Federal Regulations
For the reasons set out above, the Commission is amending title 17,
chapter II of the Code of Federal Regulations as set forth below:
PART 276--INTERPRETATIVE RELEASES RELATING TO THE INVESTMENT
ADVISERS ACT OF 1940 AND GENERAL RULES AND REGULATIONS THEREUNDER
0
1. Part 276 is amended by adding Release No. IA-5249 and the release
date of June 5, 2019, to the end of the list of interpretive releases
to read as follows:
----------------------------------------------------------------------------------------------------------------
Subject Release No. Date FR vol. and page
----------------------------------------------------------------------------------------------------------------
* * * * * * *
Commission Interpretation Regarding IA-5249 June 5, 2019............. [Insert FR Volume Number] FR
the Solely Incidental Prong of the [Insert FR Page Number]
Broker-Dealer Exclusion from the
Definition of Investment Adviser.
----------------------------------------------------------------------------------------------------------------
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\81\ To the extent this interpretation results in altered
compliance costs for standalone broker-dealers, non-affected
standalone broker-dealers (i.e., those standalone broker-dealers
that already are in compliance with the solely incidental prong as
we have interpreted it), dual registrants, investment advisers, and
other financial intermediaries that are not required to register as
investment advisers (such as banks, trust companies, insurance
companies, commodity trading advisers, and municipal advisors) may
to a varying degree gain business at these affected broker-dealers'
expense.
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By the Commission.
Dated: June 5, 2019.
Vanessa A. Countryman,
Acting Secretary.
[FR Doc. 2019-12209 Filed 7-11-19; 8:45 am]
BILLING CODE 8011-01-P
