When Should a Broker-Dealer Be Treated as an Investment Adviser?; Outside Counsel

New York Law Journal Review Online (2011)

St. John's Legal Studies Research Paper No. 19-0014

5 Pages Posted: 15 May 2019

Date Written: August 1, 2011

Abstract

When a broker-dealer should be treated as an investment adviser is an issue that has been around since the 1930s. If a broker-dealer is an “investment adviser” as that term in broadly defined in the Investment Advisers Act of 1940, the broker-dealer becomes subject to all of the substantive restrictions and record-keeping requirements of the Investment Advisers Act and the rules that the Securities and Exchange Commission has promulgated pursuant to its authority under the act. Particularly troubling to broker-dealers is the general fiduciary duty to advisees that the U.S. Supreme Court has read into §206 of the act and the principal trading restrictions contained in §206(3), which apply when an investment adviser trades for its own account with an advisee. The SEC has taken a very strict view of these restrictions, requiring prior advisee permission for each separate trade. Broker-dealers have been able to rely upon the exemption contained in §202(a)(11)(C) of the Investment Advisers Act to avoid registration under the act when they provide only “incidental” investment advice and they receive no “special compensation” for this advice.

The latest iteration of the issue of when a broker-dealer should be treated as investment adviser is the SEC study released in January 2011. The study was done pursuant to congressional directive contained in section 913 of the Dodd-Frank Act. Congress in particular asked the SEC to study “the potential impact of eliminating the broker and dealer exemption from the definition of ‘investment adviser’ under section 202(a)(11)(C) of the Investment Advisers Act of 1940. The SEC staff rejected eliminating the exemption. In light of this recommendation, it seems quite unlikely that the exemption will be disappearing any time soon even if the commission acts upon any of the staff’s recommendations, which itself seems unlikely.

Section 202(a)(11)(C) will remain of crucial importance to attorneys advising broker-dealers. The definition of “investment adviser” contained in §202(a)(11) is quite broad. It would capture all broker-dealers who did anything other than executions if the exemption in subsection (C) did not exist. The exemption contains two elements, both of which any broker or dealer relying upon it must meet. First, the broker-dealer’s “performance” of such [investment advisory] services [must be] solely incidental to the conduct of his business as a broker or dealer. Second, the broker-dealer must not receive any “special compensation” for the performance of such services (emphasis added). Two recent cases address these two separate elements of the exemption in some detail.

Suggested Citation

Facciolo, Francis, When Should a Broker-Dealer Be Treated as an Investment Adviser?; Outside Counsel (August 1, 2011). New York Law Journal Review Online (2011), St. John's Legal Studies Research Paper No. 19-0014, Available at SSRN: https://ssrn.com/abstract=3357892

Francis Facciolo (Contact Author)

St. John's University School of Law ( email )

8000 Utopia Parkway
Jamaica, NY 11439
United States
7189901832 (Phone)
7185911855 (Fax)

HOME PAGE: http://www.stjohns.edu/law

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
18
Abstract Views
318
PlumX Metrics