Does the SEC Ruling Related to the Status of Your Broker-Dealer Affect Your Pension Plan?

On March 30, 2007, The U.S. Court of Appeals for the District of Columbia Circuit ruled that the SEC exceeded its authority in granting a 2005 disclosure exemption to brokers who provide investment advice that is incidental to their business, but who nonetheless are paid a special fee for the advice. This effectively eliminated the broker exemption created by that SEC rule.

The broker exemption rule, known as “the Merrill Lynch rule,” had exempted broker-dealers that provided investment advice from registration under the Investment Advisers Act of 1940 if the advice was “solely incidental to brokerage services provided on a customer account” and if the specific disclosure was made to the customer.

By allowing broker-dealers to offer investment advice without being required to register as an investment adviser, brokers argued that they did not assume fiduciary status.

“The greatest impact will be on broker/consultants who operate with one of the wire houses,” says Donald Trone, founder and chief executive officer of Fiduciary 360 in Sewickley, Pa., “because wire house brokers are now regulated as brokers and not as investment advisers. To continue servicing retirement plans, brokers/dealers not already affiliated with an investment adviser may have to either affiliate with investment advisers or register themselves as investment advisers with either the SEC or state.”

Additionally, it will be impossible for brokers to avoid fiduciary status to their retirement plan clients. Investment advisers are automatically considered as plan fiduciaries, Trone explained.

Broker-dealers may have to reconsider the fee structures. If determined to be a fiduciary, compensation received from retirement plans can vary based on the advice given, and ERISA requires that plan fiduciaries’ compensation is “level” or fee neutral. This means no variable compensation based on whatever asset class, fund family or share class plan participants invest in.

Trone also explained there are other issues besides fee structure if brokers are fiduciaries. Many wire houses do not allow their brokers to assume fiduciary responsibility and most 401(k) products are designed as a broker product. Bundled vendors will need to retool products so that they can be serviced by a fiduciary intermediary.

Although firms are required to disclose that fee-based brokerage accounts are not advisory accounts, that distinction was probably lost on most investors. “The average investor has no clue what standard a broker is held to,” said Chip Roame of Tiburon Strategic Advisors, a financial-services consulting firm.

"The brokers aren't ready to be advisers - that's probably the biggest hurdle," says Jeffrey Strange, a Cerulli research analyst. "When you go into that advisory context, you need more integrity around asset allocation than what these [brokerage] accounts are built for," Strange said.

As a plan sponsor, you are required to provide due diligence and ask the question: Is my current broker-dealer properly registered as an investment adviser?

Please call Jere Cowden or Jim Bartoszewicz of Cowden Advisers, Inc. (412-394-9330 or by email) to discuss your concerns and how to best assure you are properly adhering to your fiduciary responsibilities as a plan sponsor.