Tuesday, May 15, 2007
I was very surprised at the SEC’s announcement yesterday that it would not seek rehearing of FPA v. SEC (D.C. Cir. Mar. 30, 2007), in which the court vacated, in its entirety, SEC Rule 202(a)(11)-1. The brokerage industry had been lobbying the SEC hard for a rehearing petition, and indeed, just last week Commissioner Paul Atkins said he thought the SEC should do so. Instead, the SEC is requested a four-month stay of the decision, to allow time for investors and brokers to respond to the decision. Chairman Cox also stated that the SEC was committed to take the opportunity “to improve investors’ ability to make educated decisions about their investment accounts and their financial services providers.”
The controversy over the Rule, and the reason the Financial Planners Association brought the lawsuit, is its exemption of broker-dealers offering fee-based accounts from regulation as investment advisers. The D.C. Circuit (2-1 decision) held that the SEC exceeded its authority in granting this exemption. The court, in a startling example of narrow statutory interpretation, held that since the statute set forth one exemption for broker-dealers, the SEC could not use its statutory authority to promulgate rules exempting “other persons” to create an additional exemption for broker-dealers. (I have previously written that the SEC Rule was bad policy, but I never doubted the SEC's statutory authority to promulgate it.)
Chairman Cox also announced that the SEC was accelerating the timetable of a previously commissioned study by the RAND Corporation on how the different regulatory systems that apply to broker-dealers and investment advisers affect investors, which is expected “to provide an important empirical foundation for considering improvements in regulatory and legislative rules that date back to the 1930s.” This suggests that the SEC has given up on the D.C. Circuit and plans, instead, to propose legislative changes.
Another part of the vacated SEC Rule has received much less attention. It allowed full-service brokerage firms to offer discount, execution-only services without being deemed investor advisers. Under prior SEC interpretations going back to 1978, a two-tier pricing system for commissions (with or without advice) meant that the brokerage firm was receiving “special compensation” for its advice and fell within the definition of “investment adviser.” Because the D.C. Circuit vacated the Rule in its entirety, the earlier interpretation presumably is still in effect. Indeed, the D.C. Circuit made a point of setting forth the prior interpretation in a footnote and approvingly noted that it was based on the SEC’s “contemporaneous” (i.e., 1940) views of the statute.
The exemption allowing two-tier pricing programs was not an issue in the FPA litigation, and, so far as I know, no one considered this aspect of the Rule controversial. It may be that the SEC can simply rescind its 1978 interpretation as an erroneous and strained interpretation of the “special compensation” language in the statutory definition to allow two-tier pricing programs. This would make good sense, but I have not seen any discussion about what the SEC intends to do about this.