Wednesday, May 16, 2007

No Mas - SEC Does Not Appeal Merrill Rule Decision

The SEC had until yesterday to file an appeal of the court decision which struck the so-called Merrill Lynch Rule - and apparently decided not to do so, according to various press reports.

The next few weeks will be interesting, as the Commission needs to deal with the void created by the absence of the rule, which effectively allowed broker-dealers to charge wrap fees for financial advice, without being registered as an investment advisor.

However, the situation is hardly the dire circumstance that some of the media is portraying. The New York Post described the situation by saying "Wall Street is scrambling to deal with nearly $300 billion of client money suddenly thrown into limbo thanks to a slap in the face from SEC boss Chris Cox."

"dire circumstance"? "slap in the face"? A bit of hyperbole, even for the Post. The fact is that the situation is hardly dire. The court decision simply puts us back to where we were before the Merrill Lynch Rule, and to where we have been for some 50 plus years. Brokerage firms can only provide financial advice if it is incidental to their business of buying and selling stocks.

The the increasing popularity of wrap fee accounts - where investors pay a flat fee regardless of how many trades they enter - the line between a broker and an investment advisor has certainly become blurred, and subject to interpretation. Brokerage firms are now faced with a decision - create a registered investment advisory subsidary and move the fee based accounts to the sub, or make sure that the fee based accounts are paying for executions, and not advice.

Of course, the second choice is not what firms want to do. They want to ultimately be responsible for investment decisions and they want to get paid for the advice that accompanies those investment decisions.

While registering as an investment advisor adds to the regulatory burden and cost, it is now the only way to address this situation - the alternative being to give up providing advice on portfolio management and financial planning.

Of course, Congress could fix this all in a flash - exempt broker-dealers from the registration requirements of the Investment Advisor's Act. Given the fact that broker-dealers already operate in the most regulated arena in the world, there simply is no reason for this divide in our regulatory scheme. Let's fix the situatio by allowing broker-dealers to provide advice, and keeping the current scheme where investment advisors do not charge transaction based fees.

Nice and simple. If you want to be a full service financial firm, you become a broker-dealer. If you want to provide financial planning and investment advice, without transaction based fees, you become an investment advisor.

Is Congress listening?
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