March 30, 2007 / 10:31 PM / 13 years ago

UPDATE 1-US court strikes down SEC broker exemption rule

(Adds SEC comment)

By Karey Wutkowski

WASHINGTON, March 30 (Reuters) - A federal appeals court on Friday overturned a U.S. Securities and Exchange Commission rule exempting certain broker-dealers who offer investment planning advice from strict disclosure requirements.

In the latest in a series of legal setbacks for the SEC, the U.S. Court of Appeals for the District of Columbia Circuit said the SEC exceeded its authority in granting a disclosure exemption to brokers who provide investment advice that is incidental to their business but who are still paid a special fee for the advice.

The SEC issued the exemption to clear up regulatory confusion so that brokers could offer fee-based accounts without having to register as financial advisers, according to the Securities Industry and Financial Markets Association, which represents some of the biggest Wall Street companies.

But the Financial Planning Association (FPA), which brought the case, argued that the exemption allowed stock brokers to dispense advice without disclosing conflicts of interest. The group represents accountants, bankers, attorneys, insurance agents and others who offer financial planning services.

“We have always contended this is a consumer protection issue,” said Duane Thompson, managing director of the FPA’s Washington office. “It will be making it easier for consumers to understand who they’re dealing with if there’s going to be full disclosure.”

SEC spokesman John Nester said the agency would “analyze the opinion and proceed appropriately in investors’ best interests.”


Thompson said the court decision levels the playing field between stock brokers and financial planners, who under the Investment Advisers Act must register and maintain records as well as limit the types of contracts they enter into.

The law carves out six exemptions from the definition of “investment adviser,” including any broker or dealer “whose performance of such services is solely incidental to the conduct of his business as a broker or dealer” and “who receives no special compensation therefor.”

It also gave the SEC the power to exempt other persons not within the intent of the law’s other exemptions.

The SEC in April 2005 adopted a rule exempting broker-dealers from the act’s requirements when they do receive special compensation for the advice if the advice is “solely incidental to brokerage services provided on a customer’s account” and if specific disclosure is made to the customer.

In its lawsuit, the FPA contended the law intended to give the SEC the power only to exempt new groups, not to expand the groups Congress had specifically addressed.

“In the wake of this decision, our highest priority must be to our investors, ensuring there is no disruption to our customers while we wait for the SEC to provide interim guidance which conforms to the court’s ruling,” said Ira Hammerman, general counsel at the Securities Industry and Financial Markets Association, in a statement.

“In the meantime, we encourage firms affected by today’s verdict to comply with the decision while simultaneously working to provide customers as much disclosure as is reasonable, given the ruling.”

The court ruling was the latest in a series of rebukes to the SEC.

Last September, the U.S. 2nd Circuit Court of Appeals overturned 16 years of SEC practice in which corporations had routinely been allowed to exclude certain shareholder proposals from proxies.

In June, a federal court struck down a five-month-old SEC rule that forced most hedge funds to register with the agency and gave SEC auditors regular access to the funds’ books.

And in April 2006, an SEC rule mandating that chairmen of mutual fund boards and 75 percent of fund directors be independent was put on hold after a federal appeals court said the SEC gave inadequate attention to possible alternatives and to the rule’s costs.

SEC Commissioner Paul Atkins said in a speech in February that the SEC is looking at how to improve its rulemaking processes. “With respect to rulemaking, we learned in 2006 that other branches of government will not be shy in holding the SEC accountable.”

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