Certain Broker-Dealers Deemed Not to Be ... - White & Case

This article originally appeared in slightly different form in the June 2005 issue of 

Banking & Financial Services Policy Report. 

Certain Broker-Dealers 

Deemed Not to Be 

Investment Advisers 

Kevin Keogh, Gregory Gnall, and Claudette Robertson Druehl 

White & Case 

On April 12, 2005, the Securities and 

Exchange Commission (SEC) adopted 

Rule 202(a)(11)-1 under the Investment 

Advisers Act of 1940 (Advisers Act) 

under which certain broker-dealers may 

provide brokerage services for fee-based 

compensation without falling within the 

defi nition of an “investment adviser” and 

being subject to registration and other 

requirements under the Advisers Act. 1 

The proposed rule was the subject of 

numerous comment letters and was the 

subject of a suit brought by the Financial 

Planning Association. 2 

Under the Advisers Act, an “investment 

adviser” is a person who, for compensation, 

engages in the business of advising others, 

either directly or through publications 

or writings, as to the value of securities 

or as to the advisability of investing in, 

purchasing, or selling securities, or who 

for compensation or as a part of its regular 

business, issues or promulgates analyses or 

reports concerning securities. “Investment 

Adviser” does not include certain fi nancial 

institutions or professionals (banks, bank 

holding companies, lawyers, accountants, 

etc.) who are not holding themselves out 

to the public as investment advisers and 

whose provision of advisory services is 

merely incidental to the practice of their 

professions. Similarly, a broker or dealer is 

not deemed to be an investment adviser 

if the “performance of such services 

are solely incidental to the conduct of 

his business as a broker or dealer and 

[the broker-dealer] receives no special 

compensation therefor.” 3 

Traditionally, the divisions between 

incidental broker-dealer activities and 

investment advisory activities were fairly 

clear. In 1940, when the Advisers Act 

was enacted, broker-dealers provided 

varied and extensive “brokerage house 

advice” on a range of subjects, including 

corporations, municipalities, governments, 

general business and fi nancial conditions, 

and tax consequences of certain 

transactions. 4 The fi rms also provided 

research to their customers as part of 

their regular advice. In addition, brokerage 

fi rms provided advice through “investment 

advisory departments” in which customers 

were charged a distinct fee for advisory 

services. Brokerage fi rms offered 

“advisory” accounts in which the broker 

would provide opinions about recommended 

holdings in the account and 

“discretionary” accounts in which the 

broker-dealer had control over the client’s 

funds with the ultimate authority to 

determine which securities should be 

purchased and sold in the client’s 

portfolio. Those providing separate investment 

advice for compensation were 

ultimately defi ned as investment advisers 

Kevin Keogh 

Partner 

Gregory Gnall 

Partner 

Claudette Robertson Druehl 

Associate 

JUN 2006 | 01642 1

Certain Broker-Dealers Deemed Not to Be Investment Advisers 

under the Advisers Act and required to register; 

broker-dealers providing general advice ancillary to 

the brokerage services and who continued to charge a 

transaction-based commission were excepted 

from the defi nition of investment adviser but still 

regulated under the Securities Exchange Act of 1934 

(Exchange Act). The SEC determined that the Advisers 

Act “was intended to cover broker-dealers only to 

the extent that they were offering investment advice 

as a distinct service for which they were specially 

compensated.” 5 

After the elimination of fi xed commission rates in 

1975, the brokerage industry evolved to include both 

discount and full-service brokers and the eventual 

development of fee-based accounts. This latter 

practice was a consequence of the recognition of 

the inherent confl icts arising out of the payment 

of commissions to full-service brokers by the 

Committee on Compensation Practices (also known 

as the Tully Committee), which in 1995, identifi ed 

as a best practice compensating representatives 

based on account assets and not on a transactional 

basis. However, this practice has tended to blur 

the distinctions between brokerage and advisory 

activities and raised the issue of whether fee-based 

compensation amounted to “special compensation” 

under the Advisers Act. Rule 202(a)(11)-1 was 

pro posed, in part, to limit the uncertainty that 

broker-dealers faced in offering fee-based advice. 

The SEC believes that the “primary effect of the Rule 

202(a)(11)-1 will be to maintain the historical ability of 

full service broker-dealers to provide a wide variety 

of services, including advisory services, to brokerage 

customers, without requiring those broker-dealers to 

treat those clients as advisory clients.” 6 

Exception for Fee-Based Brokerage Accounts 

Under Rule 202(a)(11)-1(a), a broker is not required to 

treat its brokerage customers as advisory clients solely 

because of the broker-dealer’s fee-based compensation. 

To rely on this exception, a broker-dealer registered 

under the Exchange Act must satisfy both of the 

following conditions: (1) Any investment advice must 

be solely incidental to that of the brokerage services 

provided to the account and must be provided on 

a non-discretionary basis, and (2) advertisements, 

contracts, agreements, and other account documentation 

must include a prominent statement that the 

account is a brokerage account and not an advisory 

account and that the broker’s interests may not be the 

same as the customer’s. The prominent disclosure 

must identify a person at the fi rm with whom clients 

can discuss the differences between advisory and 

brokerage accounts. 

Solely Incidental to Brokerage Services 

The broker-dealer may rely on this exception only if 

the advice provided to any account is solely incidental 

to brokerage services provided by the broker-dealer 

to that account and not to the overall operations of 

the broker-dealer. Accordingly, the advice that the 

broker-dealer provides must be non-discretionary 

advice. Discretionary accounts subject to an asset-based 

fee will be subject to the Advisers Act. These types 

of accounts are substantially similar to traditional 

advisory accounts, and the SEC staff believes that 

such accounts were within the scope of Congress’s 

legislative intent when enacting the Advisers Act 

in 1940. 

Customer Disclosure 

Rule 202(a)(11)-1(a) provides that customer account 

documents must emphasize the differences between 

a brokerage account and advisory account and that all 

customer documents include the following statement in 

a prominent manner as provided in Rule 202(a)(11)-1(a). 

Your account is a brokerage account and not an 

advisory account. Our interests may not always 

be the same as yours. Please ask us questions 

to make sure you understand your rights and our 

obligations to you, including the extent of our 

obligations to disclose confl icts of interests and 

to act in your best interest. We are paid by you 

and, sometimes, by people who compensate us 

based on what you buy. Therefore, our profi ts, 

and our salespersons’ compensation, may vary 

by product and over time. 

Firms may make minor modifi cations to the required 

disclosure to fi t individual circumstances, but may 

2


not materially alter the substance of the disclosure. 

In addition, the broker-dealer must identify the 

appropriate person with whom customers can 

discuss the differences between the two types 

of accounts. 

Discount Brokerage Programs 

Rule 202(a)(11)-1(a)(2) provides that a broker-dealer 

will not be considered to have received special 

compensation only because it charges different customers 

different commissions, mark-ups, mark-downs, 

or similar fees. In the Adopting Release, the SEC 

staff states that this provision is intended to keep a 

full-service broker-dealer from being subject to the 

Advisers Act solely because it offers electronic or 

discount brokerage services. A discount broker will 

not be subject to the Advisers Act if it provides full 

service brokerage. 7 

Scope of Exception 

Rule 202(a)(11)-1(c) provides that a broker-dealer 

subject to the Advisers Act would be considered an 

investment adviser solely with respect to the accounts 

that subject it to the Advisers Act. This provision is 

in line with the SEC’s earlier interpretation of the 

Advisers Act allowing a broker-dealer registered 

under the Advisers Act to distinguish its brokerage 

customers from its advisory clients. 

Solely Incidental To 

The exceptions from adviser registration in § 202(a)(11)(C) 

and new Rule 202(a)(11)-1 are available to broker-dealers 

only with respect to advice that is solely incidental to 

the broker-dealer’s business or account, respectively. 

Examples of advice that would be incidental to the 

business or an account include advising clients to 

enter or to stay out of the market in general or to 

participate in or refrain from a specifi c transaction 

or providing generalized market reports. Similarly, 

the SEC staff states that investment advice is 

solely incidental to the conduct of a broker-dealer’s 

business and to brokerage services when the 

“advisory services rendered are in connection with 

and reasonably related to the brokerage services 

provided.” 8 In response to many comments regarding 

the meaning of “solely” and “incidental,” the SEC 

staff has identifi ed the following circumstances under 

which it believes the provision of advisory services 

by a broker-dealer would not be solely incidental 

to brokerage (and therefore would not fi t within 

the exception). 

Separate Contract or Fee 

Under the Advisers Act, a broker-dealer that 

separately contracts with a customer for investment 

advisory services cannot be considered to be 

providing advice that is solely related to its brokerage 

advice. In the Adopting Release, the SEC staff states 

that advisory services are not solely incidental to 

brokerage services when those services are provided 

for a separate fee, because the charging of a separate 

fee in itself recognizes that the advisory services are 

provided independently of the brokerage services. 9 

Financial Planning 

Under the new rule, a broker-dealer will not be 

considered to be providing advice solely incidental to 

brokerage services if it provides advice as part of a 

fi nancial plan or in connection with providing planning 

services and (1) holds itself out generally to the 

public as a fi nancial planner or as providing fi nancial 

planning services, (2) delivers a fi nancial plan to its 

customers, or (3) represents to the customer that 

the advice is presented as part of a fi nancial plan or 

as fi nancial planning services. When a broker-dealer 

provides this type of fi nancial planning advice, if the 

broker-dealer also advertises, it must register as 

an adviser unless another exemption from the 

registration requirements is available. In addition, a 

broker-dealer must treat customers receiving this 

type of fi nancial planning advice as advisory clients. 

The SEC received many comment letters regarding 

what type of advice provided in connection with 

fi nancial planning was not “solely incidental” to 

brokerage advice. Instead of determining where 

a suitability analysis ends and fi nancial planning 

begins, the SEC staff determined that the test would 

3


be the way in which a broker-dealer holds itself out 

to the public. Under the new rule, the broker-dealer is 

subject to the Advisers Act if it portrays itself to the 

public as a fi nancial planner or as providing fi nancial 

planning services, whether it uses these particular 

terms or not. Whether a document is considered 

a fi nancial plan or services considered fi nancial 

planning services will depend on the characteristics 

of the particular plan or services. 

Holding Out to the Public 

The new rule does not include any other limitations 

on how a broker-dealer may hold itself out, including 

use of the terms fi nancial adviser or fi nancial 

consultant, in order to fi t within the exception under 

the Advisers Act. The SEC staff concludes that a 

better approach is to require broker-dealers to inform 

clients clearly that the relationship is a brokerage and 

not advisory relationship, as addressed in the required 

disclosure. Accordingly, broker-dealers may use the 

terms fi nancial advisors or fi nancial consultants or 

similar names and not be required to register as an 

investment adviser, so long as the other conditions 

of the rule have been met. 

Discretionary Asset Management 

Discretionary investment advice is not “solely 

incidental to” brokerage services within the meaning 

of the new rule under § 202(a)(11)(C) of the Advisers 

Act. Broker-dealers will not be excepted from the 

Advisers Act for any accounts over which they 

exercise investment discretion regardless of whether 

the broker-dealer is receiving special compensation 

for the investment advice and regardless of how 

the broker-dealer handles other accounts. The SEC 

is following the same interpretation of “investment 

discretion” currently applicable to broker-dealers 

under the Exchange Act. 10 

The new rule is a change from the existing SEC 

approach in this area. Under the new rule, the 

exception from adviser registration is not available 

for any account over which the broker-dealer has 

any investment discretion regardless of the form 

of compensation or how the broker-dealer handles 

other accounts. However, the SEC recognizes the 

need for some exceptions from strictly following 

§ 3(a)(35) of the Exchange Act; a broker-dealer may 

exercise investment discretion on a temporary or 

limited basis and still be eligible for the exception in 

the following types of circumstances: 

■ As to the price or time at which to execute an order 

given by a customer for the purchase or sale of a 

defi nite amount or quantity of a specifi ed security; 

■ On an isolated or infrequent basis to purchase or 

sell a security or type of security when a customer 

is unavailable for a limited period of time not to 

exceed a few months (for example, a customer 

may be on vacation and provide specifi c 

instructions as to the handling of the account 

during this time); 

■ As to cash management, such as to exchange a 

position in a money market fund for another money 

market fund or cash equivalent; 

■ To purchase or sell securities to satisfy margin 

requirements; 

■ To sell specifi c bonds and purchase similar bonds 

in order to permit a customer to take a tax loss on 

the original position; 

■ To purchase a bond with a specifi ed credit rating 

and maturity; and 

■ To purchase or sell a security or type of security 

limited by specifi c parameters established by the 

customer (type of issuer, amount, maturity, and 

yield must be specifi ed by the customer). 

Wrap-Fee Sponsorship 

In the Adopting Release, the SEC staff reaffi rms its 

traditional position that portfolio manager selection 

and asset allocation services by broker-dealers 

involved in wrap-fee programs are advisory services 

that are not solely incidental to brokerage services. 

Broker-dealers involved as such in wrap-fee programs 

will not be excepted from adviser registration. 

4


Open Issues 

The adoption of the new rule leaves many questions 

unanswered. The Chairman of the SEC has directed 

the SEC staff to report within 90 days on ways in which 

the open issues may be addressed. The SEC staff is 

also to report on options and recommendations for 

a study to compare the different levels of protection 

for retail customers of fi nancial service providers 

under the Exchange Act and Advisers Act, and to 

recommend ways to address investor protection 

concerns arising from material differences between 

the two sets of regulations. The scope of the study 

would include the following areas: 

■ Should the SEC seek legislation that would integrate 

the existing regulatory schemes applicable to 

broker-dealers and investment advisers that provide 

services to retail clients? 

■ Should sales practice standards and advertising 

rules applicable to advice provided by broker-dealers 

be enhanced? 

■ Should broker-dealers who provide investment 

advice but who are excepted from the Advisers 

Act be subject to the fi duciary obligations imposed 

by the Advisers Act on investment advisers? 

■ Should obligations under the Advisers Act applicable 

to dually registered broker-dealers be modifi ed or 

streamlined to eliminate regulatory overlap and 

reduce regulatory burdens? 

■ Are there areas that the SEC, alone or with other 

agencies, can engage in investor education efforts to 

assist investors to better understand the duties and 

obligations of their fi nancial services providers? 

Effective Dates 

The new rule became effective April 15, 2005. The 

provision of the rule regarding the prominent disclosure 

(Rule 202(a)(11)-1(a)(1)(ii)) is effective May 23, 2005. 

Broker-dealers relying on Rule 202(a)(11)-1(a)(1) must 

comply with the disclosure provisions beginning on 

July 22, 2005. 

All advertisements for contracts, agreements, 

applications, and other forms governing accounts 

opened after July 22, 2005, must include the 

prominent disclosure. Brokers are not required to 

amend existing contracts to include the disclosure 

for accounts opened prior to July 22, 2005. 

Broker-dealers relying on Rule 202(a)(11)-1(b)(3) 

regarding exercise of investment discretion that is not 

“solely incidental” to brokerage services must treat 

commission-based accounts as advisory accounts 

no later than October 24, 2005. Broker-dealers must 

treat accounts to which it provides advisory services 

pursuant to Rule 202(a)(11)-1(b)(1) and (2) as advisory 

accounts no later than October 24, 2005. 

The application of the new Rule may create interesting 

challenges for broker-dealers who traditionally were 

able to rely on the exception from investment adviser 

registration, particularly where a broker-dealer which 

acts with discretion receives only transaction-related 

compensation. 

Kevin Keogh is a partner in White & Case’s 

New York Securities Practice Group. Mr. Keogh’s 

practice involves securities transactions, acquisitions, 

divestitures, joint ventures, corporate counseling and 

strategic advice. Gregory Gnall is counsel in 

White & Case’s Securities Practice Group in New York. 

Mr. Gnall is involved in establishing broker-dealers, 

overseeing their registration with the SEC and applying 

for membership with NASD and the NYSE. He also 

creates broker-dealer supervisory and operational 

procedures. Claudette Robertson Druehl is an 

associate in White & Case’s Securities Practice Group, 

concentrating on state securities laws and 

broker-dealer and investment adviser regulation. 

The information in this article is for educational 

purposes only; it should not be construed as 

legal advice. 

Copyright © 2006 White & Case LLP 

5


1 See 17 C.F.R. Part 275, Release Nos. 34-51523, IA-2376, File No. 

S7-25-99, 70 FR 20424 (Adopting Release). The rule was initially 

proposed in 1999 (Release Nos. 34-42099, IA-1845 File No. S7-25- 

99, 64 FR 61226 (Nov. 10, 1999)) and re-proposed in January 2005 

(see Release Nos. 34-50980, IA-2340, File No. S7-25-99, 70 FR 

2716 (Jan. 14, 2005)). 

2 See Financial Planning Ass’n v. Securities and Exchange 

Commission, No. 04-1242 (D.C. Cir., fi led July 20, 2004). The suit 

claimed that the SEC’s failure to adopt a fi nal rule and its reliance 

on an embedded no-action position to except certain brokerdealers 

from falling within the Advisers Act violated the Advisers 

Act and the Administrative Procedure Act and was “arbitrary 

and capricious.” The action was stayed pending reproposal and 

adoption of the rule. 

3 Advisers Act § 202(a)(11). 

4 See Adopting Release at 19. 



7 Adopting Release at 45. 



10 A person exercises “investment discretion” with respect to 

an account pursuant to § 3(a)(35) of the Exchange Act if the 

person (1) is authorized to determine which securities or other 

property shall be purchased or sold by or for the account, (2) 

makes decisions as to what securities or other property shall be 

purchased or sold by or for the account even though some other 

person may have responsibility for such investment decisions, or 

(3) otherwise exercises infl uence with respect to the purchase 

or sale of securities or other property by or for the account as the 

SEC determines should be subject to the Exchange Act. 

6

Certain Broker-Dealers Deemed Not to Be ... - White & Case

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