By broadening securities law to allow broker-dealers to offer advice and charge for it, the Securities and Exchange Commission’s best-interest violates the Investment Adviser’s Act of 1940 and more recent court rulings, Michael Kitces, president of the 700 advisor firm XY Planning Network, argued in a comment letter he sent to the agency this week.

“Regulation Best Interest as proposed would appear to violate the existing 'broker-dealer exception' under the Investment Advisers Act of 1940,” said Kitces, also principal of the Maryland-based Pinnacle Advisory Group, an independent registered investment advisor.

The ’40 Act provides only a very specific and narrow scope for broker-dealers to avoid offerings that may be construed as “advice” that would trigger a requirement to register as an investment advisor and a fiduciary, Kitces argued.

Kitces makes the case that the SEC simply doesn’t have the authority to expand broker-dealers’ ability to offer advice.

To preserve consumer choice when creating a fiduciary standard for those who do offer advice, Congress specifically carved out an exception for broker-dealers that stated that the investment advisor term did not include: “…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,” said Kitces.

Incidental advice occurs either by chance, as a consequence of product sales or without intent to give advice, argued Kitces.

While the brokerage industry believes the SEC’s proposal goes too far in hamstringing their advice offerings, Kitces asked, if broker advice should be a free and incidental consequence of broker-dealer product sales, why does the SEC repeatedly characterize its broker proposal as a “model for advice?”

“In violation of the ‘40s Act, the SEC’s Regulation Best Interest repeatedly characterizes the broker-dealer model as a ‘model for advice,’ variously calling it a ‘pay as you go’ model for advice, suggesting that preserving the broker-dealer model is about 'preserving investor choice across products and advice models' and advocating for 'continuing existence of the broker-dealer model as an option for retail customers seeking investment advice,'" said Kitces.

“The very announcement of the proposal itself by Commissioner Clayton stated: “The specific obligations of investment advisers and broker-dealers would be, however, tailored to the differences in the types of advice relationships that they offer,” Kitces noted.

“Clearly, declaring broker-dealers as a model for advice directly violates the plain language of the narrow, solely incidental exception, which FPA vs SEC already noted that the SEC does not have purview to expand,” Kitces added.

Kitces was referring to a landmark victory for the Financial Planning Association, which sued and won, when the SEC attempted to expand broker-dealers’ exemption to offer advice through rulemaking in 2005. The SEC rule was vacated by the D.C. Circuit Court of Appeals in 2007.

Merril Hirsh, the Washington D.C.-based attorney who represented the FPA in the lawsuit, told Financial Advisor magazine, “The case established that there are obvious limitations on what the SEC can do and that it was beyond the authority of the SEC to create a broader exception than Congress provided for brokers in the Investment Advisers Act.” 

“We argued that the statute said unless brokers fit the narrow solely incidental exemption, they’re holding themselves out as investment advisors and are subject to registration and the SEC agreed,” Hirsh added.

“The Commission makes this change to the scope of the 'solely incidental' advice clause without acknowledging it is doing so, or justifying how such a change is legally permissible, especially in light of the court’s ruling in FPA vs SEC regarding the Commission’s limitation to expand the broker-dealer exemption,” he said.

“Simply put, a firm should not be able to market itself as being in the business of advice and using financial advisors or synonymous titles, and then rely on an exemption to avoid being held accountable for that advice under the ’40 Act that was only intended to apply to 'incidental' advice that is occurring by chance or without intent,” Kitces said.

“The marketing itself of such firms unequivocally affirms that the advice is not incidental and not occurring by chance or without intent,” he argued.

Kitces also noted that in both the Financial Services Institute (FSI) and the Securities Industry and Financial Markets Association (SIFMA) briefs asking the court to overturn the DOL fiduciary rule, they insisted that their brokers should not be held to a standard that they are in a relationship of trust and confidence with their customers.

“Either the brokerage industry should be believed for their marketing and use of titles as financial advisors ... or should be believed for their statements to the Fifth Circuit Court of Appeals in the Department of Labor’s fiduciary rule that they are not in the business of advice and not in an advice relationship of trust and confidence with their customers. But it surely cannot be both,” Kitces said.

“In other words, the problem is not that broker-dealers are giving advice without being subject to a fiduciary standard under Finra regulation; the problem is that broker-dealers giving such advice are required to register as investment advisers, and if they did, they would already subject them to the fiduciary standard that applies to registered investment advisers, rendering the entire Regulation Best Interest proposal moot anyway!” Kitces said.

Consumer confusion is unavoidable, Kitces said. “It is unclear how any consumer could understand their choices given the Form CRS disclosure that broker-dealers “must act in your best interest and not place our interests ahead of yours” while investment advisors “are held to a fiduciary standard” which the SEC defines as the obligation to “act in the best interest of the client” as well!” he said.

Similarly, while the SEC’s advice rule proposes to reduce consumer confusion by limiting the use of the “financial advisor” term by standalone broker-dealers and their registered representatives, the agency continues to allow hybrid advisors to use the label “knowing full well that at least a portion of the advisor’s services will not be made in his/her capacity as an advisor but as a salesperson,” Kitces argued.

“In other words, advisors are explicitly being granted permission to market their services as “advice” and implement that advice without being subject to the appropriate standard for advice and without any requirement to explain to the consumer when the advice relationship ended,” he said.

The Consumer Federation of America found in a 2017 review of the websites of 25 leading broker-dealers that all used titles that identified them as advisors or a similar term. 

“Most consumers simply cannot comprehend how a firm can state that is it offering a trusted advice relationship that by definition would be a fiduciary relationship of trust and confidence…and then not be subject to a fiduciary standard for that fiduciary relationship,” Kitces said.

Interested parties have until August 7 to comment on the SEC’s best interest, advice and customer relationship summary proposals.