Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

Friday, February 4, 2011

Tenth Circuit Interprets Broker-Dealer Exclusion in Advisers Act

A recent opinion from the Tenth Circuit addresses the broker-dealer exclusion in the Investment Advisers Act, an important and controversial statutory provision that courts have rarely interpreted.  In Thomas v. Metropolitan Life Insurance Co (10th Cir. Feb. 2, 2011)(Download Thomasv.MetLife), plaintiffs, purchasers of a variable universal life insurance policy from the Met representative, complained that defendants failed to disclose that the Met representative had strong financial incentives to sell Met's proprietary products as opposed to giving unbiased advice.  The court affirmed the district court's interpretation and held that a "financial services representative" employed by Met was not an "investment adviser" for purposes of the IAA, because he was exempt as a broker-dealer who gives advice "solely incidental to" his conduct as a broker-dealer and receives " no special compensation" for his advice. 

The district court held, first, that the applicability of the exemption depends not on the quantum or importance of the broker-dealer's advice, but on whether the broker-dealer gives advice in connection with the sale of a product.  In affirming this interpretation, the Appeals Court looked to the "plain meaning" of the statute and examined various dictionary definitions of the word "incidental."  It found that, while the definitions varied, all dictionary definitions had two components: to be considered incidental, two actions or objects must be related in a particular way -- the incidental action or object must occur only as a result of or in connection with the primary.  In addition, the incidental action or object must be secondary in size or importance to the primary.  The Court rejected the plaintiffs' emphasis on the second component of the definition as inconsistent with the dictionary definitions.  It also found support for its interpretation in SEC pronouncements and the legislative history.

As to the "special compensation" prong of the exclusion, the Tenth Circuit found the statutory language more straightforward: broker-dealers who give incidental advice are exempted from the IAA so long as they receive "no special compensation" for the advice.  The Court determined that in the overall context of the broker-dealer exemption compensation received by a broker-dealer is "special" only when (1) the compensation is received specifically in exchange for giving advice, as opposed to some other service, and (2) the compensation takes a form other than a commission or analogous transaction-based compensation received for the sale of the product. 

The facts of this case provide a good illustration of the need for harmonizing the standards of conduct for broker-dealers and investment advisers, which has been the subject of a recent SEC staff study mandated by Dodd-Frank.  Unfortunately, however, it is unlikely that the SEC will take on the issue of troublesome problem of broker-dealers that sell only proprietary products to their customers without disclosing the availability of less expensible comparable products.

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