Originally published in Financial Services Advisory Update, Volume 3, No. 1 February 2006

In 2005, the SEC adopted Rule 202(a)(11)-1 to provide an exception from the definition of "investment adviser" under the Investment Advisers Act of 1940 (Advisers Act) for certain broker-dealers that provide non-discretionary advice solely incidental to their brokerage activities. In response to a series of questions from the Securities Industry Association, the SEC on December 16, 2005, released a letter containing guidance on the application of the rule.

  • Advertising—A broker-dealer will be subject to registration under the Advisers Act if it (1) provides advice as a financial planner or as part of a financial plan and (2) holds itself out as a provider of financial planning, delivers to the client a financial plan or represents that the advice provided is part of a financial plan. A broker-dealer must meet both requirements even if it indicates that it is a certified financial planner on its business cards or letterhead. Further, a broker-dealer is not required to register merely as a result of advising a client that financial planning or other investment advisory services are available. Unless a broker-dealer provides advice to that client as part of a financial plan or in connection with providing financial planning services, the broker-dealer will not be deemed to be engaging in advisory activities with respect to that client.
  • Financial Plan—The letter clarifies when advice or the provision of a financial tool, such as a questionnaire, financial calculator, asset allocation analysis or cash flow analysis, will be considered to be part of a financial plan. Advice relating to a client’s broad or long term financial requirements, including recommendations about insurance, savings, tax planning and investments will be considered to be part of a financial plan or financial planning. However, advice that relates to a specific transaction or allocation will not be considered to be advice related to a financial plan or financial planning when not offered in the context of an overall strategy. When making this distinction, the broker-dealer should consider both its disclosure to the client and a reasonable investor’s perceptions.
  • Dual Registration—Whether or not an investment adviser client relationship (which carries a higher fiduciary duty to the client) exists between the dually registered broker-dealer/investment adviser and the client will depend on the contract between the parties, the course of dealing and reasonable expectations. Even if an advisory relationship exists, the broker-dealer is not acting in an advisory capacity with respect to a security transaction when it has not provided advice to the client on whether to buy or sell the security. This would be true even if the broker-dealer gave the client advice on its general portfolio and the same broker-dealer subsequently effects a transaction in a specific security to conform to the general advice the broker-dealer has given the client. A broker-dealer/investment adviser may discontinue its advisory relationship with its client and then assume a brokerage relationship. Both parties can agree contractually to terminate the relationship upon the occurrence of a certain event, such as the delivery of a financial plan. In order to effectively end the fiduciary relationship, there must be full disclosure of the changes in the relationship and the broker-dealer/adviser’s obligations to the client.
  • Use of Business Cards and Letterhead—A broker-dealer would not lose the availability of the "broker-dealer exception" unless one or more of its representatives both (i) provides advice as part of a financial plan or in connection with financial planning services and (ii) includes such credentials on the business card or letterhead. If the broker-dealer is dually registered, the use of these business cards or letterhead alone would not require the broker-dealer/adviser to treat as advisory clients each customer to whom a card or letterhead is delivered unless the broker-dealer/adviser also provides investment advice to that customer as part of a financial plan or in connection with financial planning services.

Firms were required to comply with the rule by January 31, 2006, but the Securities Industry Association has requested that the SEC extend the compliance date until March 31, 2006. The letter can be found at http://www.sec.gov/divisions/investment/noaction/sia121605.htm.

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