Reforming the Regulation of Broker-Dealers and Investment Advisers

Abstract

A key component of financial regulatory reform is harmonizing the law governing broker-dealers and investment advisers. Historically brokers charged commissions and were regulated under the Securities Exchange Act of 1934. Advisers charged asset-based fees and were subject to the Investment Advisers Act of 1940, which contains a special exclusion for brokers. In recent years, brokers have changed their compensation structure and many now market themselves as advisers, raising questions about whether they should be treated as such. The Obama Administration’s 2009 White Paper on regulatory reform and draft legislation call for a fiduciary duty to be imposed on brokers that provide advice. In this article, I explore the debate over regulating brokers and advisers and suggest how to resolve it. I make four key claims. First, changes in brokers’ compensation and marketing methods vitiate application of the broker-dealer exclusion and should subject brokers to the Advisers Act. Second, changes in the nature of brokerage, spurred by changes in technology, make the broker-dealer exclusion unsustainable and Congress should repeal it. I then turn to the consequences of regulating brokers as advisers. The third claim is that imposing fiduciary duties on brokers is incompatible with their historical roles as dealers and underwriters. To resolve this tension, the article suggests a compromise that enhances brokers’ duties but does not hobble their ability to perform their traditional functions. Finally, regulating brokers as advisers would overburden the SEC and the article offers alternatives to alleviate the strain.

Keywords: broker-dealer, investment adviser, securities regulation, financial regulation, fiduciary duty

JEL Classification: K22, K23, K42