Reforming the regulation of broker-dealers and investment advisers

Business Lawyer

Volumn 65, Issue 2, 2010, Pages 395-440

  Laby, Arthur B ^a  

^a and law in the military   (United States)

Author keywords

[No Author keywords available]

Indexed keywords

EID: 77951692467     PISSN: 00076899     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Article

References (442)

1. For a discussion of the financial crisis, see Symposium, Modernizing the Financial Regulatory Structure, 5 N. Y. U. J. L. & BUS. 339 (2009).
2. See Diana B. Henriques, Madoff, Apologizing. Is Given 150 Years, N. Y TIMES, June 30, 2009, at A1;
3. Diana B. Henriques, Madoff Scheme Kept Rippling Outward, Crossing Borders, N. Y. TIMES, Dec. 20, 2008, at A1;
4. Dave Kansas, Madoff Does Minneapolis, FORTUNE, Feb. 2, 2009, at 80.
5. See Bill Swindell, House Panel Wrangles over SEC Structure, CONGRESS DAILY, Oct. 6, 2009, http://www.nationaljoumal.com/congressdaily/cdp-20091006- 9014.php (subscription database).
6. See infra notes 48-66 and accompanying text.
7. See infra Part I. D.2.
8. U. S. DEP'T OF THE TREASURY, A NEW FOUNDATION: REBUILDING FINANCIAL SUPERVISION AND REGULATION 71 (2009), available at http://www. financialstability.gov/docs/regs/FinalReport-web.pdf [hereinafter TREASURY WHITE PAPER].
9. Wall Street Reform and Consumer Protection Act of 2009, H. R. 4173, 111th Cong. § 7103 [hereinafter H. R. 4173].
10. S. COMM. ON BANKING, HOUSING & URBAN AFFAIRS, 111TH CONG., RESTORING AMERICAN FINANCIAL STABILITY ACT: CHAIRMAN'S MARK TEXT (2009), available at http://banking.senate.gov/public/-files/ 111609FullBillTextofrheRestoringAmericanFinancialStabilityActof2009.pdf [hereinafter SENATE DRAFT LANGUAGE].
11. See SEC Oversight: Current State and Agenda, Hearing Before the Subconm. on Capital Markets, Insurance, and Govemmeni-Sponsored Enterprises of the H. Comm. on Financial Servs., 111th Cong. 13 (July 14, 2009) (statement of Mary L. Schapiro, Chairman, U. S. Sec. & Exch. Comm'n), available at http://www.house.gov/apps/list/hearing/financialsvcs-dem/sec-testimony.pdf [hereinafter Schapiro Statement] (stating that financial services providers that provide advice should be subject to "equivalent regulation") ;
12. Elisse Walter, Comm'r, U. S. Sec. & Exch. Comm'n, Speech at the Mutual Fund Directors Forum Ninth Armual Policy Conference-Regulating Broker-Dealers and Investment Advisers: Demarcation or Harmonization? (May 5, 2009) (transcript available at http://www.sec.gov/news/speech/2009/ spch050509ebw.htm) [hereinafter Walter Speech) ("[E]very financial professional should be subject to a uniform standard of conduct.").
13. But see Luis A. Aguilar, Comm'r, U. S. Sec. & Exch. Comm'n, Speech at Investment Advisers Association Annual Conference: SEC's Oversight of the Adviser Industry Bolsters Investor Protection (May 7, 2009) (transcript available at http://www.sec.gov/news/speech/2009/spch050709laa.htm) [hereinafter Aguilar Speech] (rejecting harmonization and analyzing how brokers that provide advice should be treated).
14. For commentary by academics and practicioneis, see Tamar Frankel, Fiduciary Duties of Brohers-Advisors-Financial Planners and Money Managers 18 (Boston Univ. School of Law Working Paper No. 09-36, 2009), available at http://papers.ssm.com/sol3/papers. cfm?abstract-id= 1446750 ("Congress should amend the law to impose on [broker-dealers] all the duties imposed by the Advisers Act.") ;
15. John C. Coffee, Jr, Changes Needed Before Fed Is Given Regulatory Mission, N. Y. L. J., July 16, 2009, at 5;
16. Thomas P Lemke & Steven W. Stone, The Madoff "Opportunity": Harmonizing the Overarching Standard of Care for Financial Professionals Who Give Investment Advice, WALL ST. LAW., June 2009, at 1, available at http://www.morganlewis.com/pubs/WSL.-TheMadoff Opponunity-june2009.pdf;
17. Michael Koffier, Six Degrees of Separation: Principles to Guide the Regulation of Broker-Dealers and Investment Advisers, 41 SEC. REG. & L. REP. (BNA) 776 (Apr. 27, 2009).
18. 15 U. S. C. A. §§ 78a-7800 (West 2009).
19. 15 U. S. C. §§ 80b-1 to 80b-21 (2006).
20. See Aguilar Speech, supra note 9;
21. see also NAT'L REGULATORY SERVS. & INV. ADVISER ASS'N, EVOLUTION REVOLUTION 2008, at 2, available at http://www.investmentadviser.org/eweb/docs/ Publications-News/Reports-and-Brochures/IAA-NRS-Evolution-Revolution-Reports/ evolution-revolution-2008.pdf (reporting assets under tnanagement for registered advisers of $42.3 trillion).
22. A RAND report puts the figure at $17 trillion. ANGELA A. HUNG, NOREEN CLANCY, JEFF DOMINITZ, ERIC TALLEY, CIAUDE BERREBI & FARRUKH SUVANKULOV, INVESTOR AND INDUSTRY PERSPECTIVES ON INVESTMENT ADVISERS AND BROKER-DEALERS 40, 51 (2008), available at http://www.sec.gov/news/prss/2008/ 2008-1-randiabdreport.pdf [hereinafter RAND REPORT).
23. Richard G. Ketchum, Chairman & CEO, Fin. Indus. Regulatory Auth., Speech at the NAVA Government & Regulatory Affairs Conference (June 8, 2009) (transcript available at www.finra.org/Newsroom/Speeches/Ketchum/P118889).
24. Aguilar Speech, supra note 9.
25. See Investment Advisers Act § 202 (a) (11) (C), 15 U. S. C. § 80b-2 (a) (11) (C) (2006).
26. Certain Broker-Dealers Deemed Not to Be Investment Advisers, Exchange Act Release No. 51523, Advisers Act Release No. 2376, 70 Fed. Reg. 20424 (Apr. 12, 2005) [hereinafter Adopting Release).
27. Fin. Planning Ass'n v. SEC, 482 F.3d 481, 493 (D. C. Cir. 2007).
28. H. R. 4173, supra note 7, § 7103.
29. SENATE DRAFT LANGUAGE, supra note 8, § 913. The final Senate bill may abandon this approach and recommend additional study into whether the approach is feasible instead.
30. See Malini Manickavasagam, Brokers May Escape Fiduciary Standard Under Final Senate Reffdatory Reform Bill, SEC. LAW DAILY (BNA), Feb. 4, 2010 (Lexis).
31. See Richard A. Posner, The President's Blueprint for Reforming Financial Regulation: A Critique: Part I, FINREG 21, July 20, 2009, http:/www.finreg21. com/lombani-stieet/the-president%E2%80%99sblueprint-reforming-financial- regulation-a-critique-part-i (attacking the white paper broadly for its failure to discuss objections).
32. Two exceptions, which predate the current financial crisis, are George Steven Swan, The Law and Economics of Interprofessional Frontier Skirmishing: Financial Plarming Association v. Securities and Exchange Commission, 16 U. MIAMI BUS. L. REV. 75 (2007)
33. and Barbara Black, Brokers and Advisers-What's in a Name?, 11 FORDHAM J. CORP. & FIN. L. 31 (2005).
34. For a recent draft article, see Frankel, supra note 9.
35. Two examinations by practitioners include Lemke & Stone, supra note 9
36. and Koffler, supra note 9.
37. Investment Advisers Act Rule 202 (a) (11)-1, 17 C. F. R. § 275.202 (a) (11)-1 (2006),
38. vacated by Fin. Planning Ass'n v. SEC, 482 F.3d 481 (D. C. Cir 2007).
39. SENATE DRAFT LANGUAGE, supra note 8, § 913.
40. One caveat: this Article does not address proposals to subject advisers to a Self-Regulatory Organization ("SRO") or to change the SEC to a self-funded agency An SRO for advisers merits extended discussion of topics such as potential conflicts, additional costs, and which body would be an appropriate SRO.
41. See generally Roberta S. Karmel, The future of Self-Regulatory Organizations, N. Y. L. J., June 18, 2009, at 3 (pointing to confvision between roles of brokers and advisers and to Bernard Madoff scandal as reasons supporting an SRO for advisets). It appears unlikely however, that the proposal will come to fruition any time soon.
42. See House Rejects FINRA Jurisdiction over Advisers, ACA INSIGHT, Dec. 14, 2009, http://www.iminsightnews.com/issues/1-254/news/2126-1.html. Similarly, self-funding calls for a careful debate over effective supervision and potential conflicts.
43. See Suzanne Barlyn, Compliance Watch: Idea of SEC Self-Funding Raises Questions, COMPLIANCE EXCHANGE, Aug. 11, 2009, http://compliancex.typepad.com/ compliancex/2009/08/compliance-watch-idea-of-sec-selffunding-raisesquestions. html. These are important topics that merit an article of their own.
44. See LOUIS LOSS & JOEL SELIGMAN, FUNDAMENTALS OF SECURITIES REGULATION 812-15 (2004).
45. See id.
46. See Nicolas Grabar, Interim Report of the Committee on Capital Markets Regulation, in FOREIGN ISSUERS & THE U. S. SECURITIES LAWS: STRATEGIES FOR THE CHANGING REGULATORY ENVIRONMENT 11, 82 (PLI Corp. Law & Practice, Course Handbook Series No. 10818, 2007).
47. See infra notes 249-57 and accompanying text.
48. See Certain Broker-Dealers Deemed Not to Be Investment Advisers, Exchange Act Release No. 50980, Advisers Act Release No. 2340, 70 Fed. Reg. 2716, 2719-20 (proposed Jan. 6, 2005) [hereinafter Reproposal).
49. See U. S. SEC. & EXCH. COMM'N, REPORT ON THE FEASIBIUTY AND ADVISABIUTY OF THE COMPLETE SEGREGATION OF THE FUNCTIONS OF DEALER AND BROKER xiv, xvi (1936) [hereinafter SEGREGATION REPORT).
50. TWENTIETH CENTURY FUND, THE SECURITY MARKETS 634 (4th prtg. 1938) ("But far more important from the viewpoint of this study is the advice-giving activity of the brokerage house.').
51. Adopting Release, supra note 16, 70 Fed. Reg. at 20428.
52. See Reproposal, supra note 29, 70 Fed. Reg. at 2720.
53. See In re Duker & Duker, Exchange Act Release No. 2350, 6 S. E. C. 386 (1939).
54. A mark-up is the difference between the price offered by other dealers and the higher price charged to a customer who is purchasing; a mark-down is the difference between the price bid by other dealers and the lower price that a dealer pays a customer who is selling. Brandon Becker, Todd Weinch & Jaime Klima, Mark-Ups, in BROKER-DEALER REGULATION (ALl-ABA Course of Study, Jan. 13-14, 2005) (available on Wesdaw at SK044 ALI-ABA 213).
55. OFFICE OF COMPLIANCE, INSPECTIONS AND EXAMINATIONS, U. S. SEC. & EXCH. COMM'N, INSPECTION REPORT ON THE SOFT DOLLAR PRACTICES OF BROKER-DEALERS, INVESTMENT ADVISERS AND MUTUAL FUNDS § II. F2 (1998), available at http://www.sec.gov/news/studies/softdolr.htm.
56. JAMES D. COX, ROBERT W. HILLMAN & DONALD C. LANGEVOORT, SECURITIES REGULATION: CASES AND MATERIALS 1027-28 (6th ed. 2009).
57. Id.
58. TWENTIETH CENTURY FUND, supra note 31, at 653.
59. Id. ("Investment banks and brokerage firms which have established special investment management departments generally follow the fee system initiated by the investment counsel").
60. Reproposal, supra note 29, 70 Fed. Reg. at 2720.
61. See H. R. Doc. No. 76-477, at 13 (1939) [hereinafter H. R. Doc. No. 76-477).
62. Id. at 5.
63. TWENTIETH CENTURY FUND, supra note 31, at 649.
64. H. R. Doc. No. 76-477, supra note 41, at 16.
65. Id. at 15.
66. See RALPH F. DE BEDTS, THE NEW DEAL;S SEC: THE FORMATIVE YEARS 3-4 (1964).
67. LOUIS LOSS & EDWARD M. COWETT, BLUE SKY LAW 5-8 (1958) (explaining that although Kansas was not the first state to adopt a securities law, it was the first to adopt a comprehensive statute requiring registration of securities and securities sales representatives).
68. Securities Exchange Act of 1934, ch. 404, 48 Stat. 881
69. (codified as amended at 15 U. S. C. A. §§ 78a-7800 (West 2009)).
70. See Securities Act of 1933, ch. 38, 48 Stat. 74
71. (codified as amended at 15 U. S. C. §§ 77a-77aa (2006)).
72. Exchange Act § 15 (c) (3), 15 U. S. C. § 780 (c) (3) (2006) (requiring the SEC to establish minimum financial responsibility requirements for broker-dealers) ;
73. id. § 10, 15 U. S. C. § 78j (2006) (prohibiting "any manipulative or deceptive device or contrivance").
74. Id. § 4, 15 U. S. C. A. § 78d (West 2009).
75. Maloney Act of 1938, Pub. L. No. 719, 52 Stat. 1070
76. (codified as amended at 15 U. S. C. § 780-3) (2006)) (adding § 15A to the Exchange Act).
77. See generally JOEL SELIGMAN, THE TRANSFORMATION OF WALL STREET 185-86 (3d ed. 2003). The NASD was the predecessor to FINRA. In 2007, FINRA was created through the combination of the NASD and the member regulation, enforcement, and arbitration functions of the New York Stock Exchange ("NYSE" or "Exchange").
78. See FINRA, ABOUT THE FINANCIAL INDUSTRY REGULATORY AUTHORITY, http://www.finra.org/AboutFINRA/index.htm (last visited Dec. 10, 2009).
79. See DWIGHT ROGERS, A BRIEF HISTORY OF THE INVESTMENT COUNSEL ASSOCIATION OF AMERICA 9 (1982).
80. See H. R. Doc. No. 76-477, supra note 41.
81. Pub. L. No. 74-833, § 30, 49 Stat. 803, 837
82. (codified at 15 U. S. C. § 79z-4)
83. repealed by Eneigy Policy Act of 2005, Pub. L. No. 109-58, § 1263, 119 Stat. 594, 974.
84. See H. R. Doc. No. 76-477, supra note 41.
85. Id. at 2, 8.
86. S. REP. No. 76-1775, at 21 (1940)
87. [hereinafter S. REP. No. 76-1775].
88. See id.
89. Pub. L. No. 76-768, 54 Stat. 847
90. (codified as amended at 15 U. S. C. §§ 80b-l to 80b-21 (2006)).
91. Investment Trusts and Investment Companies: Hearings on S. 3580 Before the Subcomm. of the S. Comm. on Banking and Currency, 76th Cong. 48, 50 (1940)
92. (statement of David S. Schenker, Chief Counsel, U. S. Sec. & Exch. Comm'n), available at http://www.sechistorical.org/museum/papers/1940/ [hereinafter Schenker Statement).
93. Investment Advisers Act §202 (a) (11), 15 U. S. C. § 80b-2 (a) (11) (2006).
94. Id. § 202 (a) (11) (C)
95. U. S. C. § 80b-2 (a) (11) (C) (2006).
96. Id.
97. S. REP. No. 76-1775, supra note 59, at 22.
98. See Adopting Release, supra note 16, 70 Fed. Reg. at 20428-29.
99. See Opinion of the General Counsel Relating to Section 202 (a) (11) (C) of the Investment Advisers Act of 1940, Advisers Act Release No. 2, 11 Fed. Reg. 10996
100. * 2 (Oct. 28, 1940) ("[M]any brokers and dealers have investment advisory departments which htmish investment advice for compensation in the same manner as does an investment adviser who operates solely in an advisory capacity").
101. See Adopting Release, supra note 16, 70 Fed. Reg. at 20440 n. 165 (discussing the SEC's "longstanding view" that accounts should be analyzed on an account-by-account basis).
102. See Final Extension of Temporary Exemption from the Investment Advisers Act for Certain Broker-Dealers, Exchange Act Release No. 14714, Advisers Act Release No. 626, 43 Fed. Reg. 19224, 19225 (Apr. 27, 1978).
103. Id. Although brokerage accounts are not deemed advisory accounts if the broker-dealer exclusion is applicable, many if not most advisory accounts would be considered brokerage accounts if the firm effected transactions for the accounts. Thus, advisory accounts of dual registrants often are subject to both regulatory regimes.
104. See Letter from Barbara Roper, Dir. of Investor Prot., Consumer Fed'n of Am., to Jonathan G. Katz, Sec'y, U. S. Sec. & Exch. Comm'n 4 (Sept. 20, 2004), available at http://www.consumerfed.org/pdfs/broker-dealer-rule-comment- ltr-09202004.pdf [hereinafter 2004 Roper Letter).
105. See id.
106. Investment Advisers Act § 202 (a) (11) (B), 15 U. S. C. § 80b-2 (a) (11) (B) (2006).
107. THOMAS P. LEMKE & GERALD T. LINS, REGULATION OF INVESTMENT ADVISERS § 1.18 (2008).
108. See Adopting Release, supra note 16, 70 Fed. Reg. at 20425.
109. See id.
110. See Gorion v. NYSE, Inc., 422 U. S. 659, 663 (1975) ;
111. see also Richard Sylla, The Origins of the New York Stock Exchange, in THE ORIGINS OF VALUE: THE FINANCIAL INNOVATIONS THAT CREATED MODERN CAPITAL MARKETS 299, 307-08 (William N. Goeumann & K. Geert Rouwenhorst eds., 2005) ;
112. Stuart Banner, The Origin of the New york Stock Exchange, 1791-1860, 27 J. LEGAL STUD. 113, 115 (1998). (Pubitemid 128426683)
113. In reality, the movement toward negotiated rates had begun much earlier For a brief history, see SELIGMAN, supra note 53, at 303.
114. See Norman S. Poser, Restructuring the Stock Markets: A Critical Look at the SEC's National Market System, 56 N. Y. U. L. REV. 883, 901 (1981).
115. See id.
116. See Leslie Wayne, The Discounters Storm Wall Street, N. Y. TIMES, Dec. 26, 1982, at 31.
117. Id. ("[T]he discounters are often order-takers rather than brokers-they offer no investment advice and have no research staffs-and typically cater to those investors who do their own homework and are only seeking someone to execute stock trades.").
118. See HOWARD M. FRIEDMAN, SECURIYIES REGULATION IN CYBERSPACE 16-58.2 (3d ed. 2009) (explaining that online trading continued the trend of unbundling advice from execution resulting in reduced commissions) ;
119. see also infra notes 219-33 and accompanying test.
120. Adopting Release, supra note 16, 70 Fed. Reg. at 20426.
121. Id. at 20428 n. 38.
122. Id. at 20425.
123. Id. ("Our staff has viewed such a two-tiered fee structure as involving 'special compensation' under the Advisers Act.").
124. Applicability of Broker-Dealer Regulation to Banks, Exchange Act Release No. 22205, 50 Fed. Reg. 28385, 28390 (July 1, 1985) ("[T]ransaction-related compensation can provide the inducement for a variety of illegal conduct, including churning."). Churning is where a broker "engages in excessive trading in disregard of his customer's investment objectives for the purpose of generating commission business."
125. Mihara v. Dean Witter & Co., 619 F.2d 814, 820 (9th Cir. 1980).
126. DANIEL P. TULLY, THOMAS E. O'HARA, WARREN E. BUFFEI, RAYMOND A. MASON & SAMUEL L HAYES 111, REPORT OF THE COMMITTEE ON COMPENSATION PRACTICES 4-5 (1995), available at www.sec.gov/news/studies/bkrcomp. txt [hereinafter TULLY REPORT].
127. Id.
128. Id. at 10.
129. Adopting Release, supra note 16, 70 Fed. Reg. at 20431.
130. TULLY REPORT, supra note 90, at 10.
131. Certain Broker-Dealers Not Deemed to Be Investment Advisers, Exchange Act Release No. 42099, Advisers Act Release No. 1845, 64 Fed. Reg. 61226, 61227 (proposed Nov. 4, 1999) [hereinafter 1999 Proposing Release] ("[S]everal full service brokerage firms have introduced or armounced new types of [fee-based] brokerage programs.").
132. See 2004 Roper Letter, supra note 72, at 4.
133. See Enhancing Investor Protection and the Regulation of Securities Markets: Hearings Before the S. Comm. on Banking, Housing, and Urban Affairs, 111th Cong. 9 (Mar. 26, 2009)
134. (statement of Mary L. Schapiro, Chairman, U. S. Sec. & Exch. Comm'n), available at http://banking.senate.gov/public/index.cfm?FuseAction=Hearings. Testimony&Hearing-ID=081fbcf6-953b-4701-ba03-e354ec6e8514&Witness-ID= 5f1a3238-4489-4c36-a371-4816c3b47bd5 (stating that the services provided by brokers and advisers are "virtually identical from the investor's perspective").
135. 1999 Proposing Release, supra note 95, 64 Fed. Reg. at 61228.
136. See id.
137. See Black, supra note 21, at 36-37 (contrasting broker's duty of suitability with adviser's fiduciary duty including duty to monitor and to avoid self-dealing transactions without informed consent) ;
138. Coffee, supra note 9 (contrasting broker's duties of suitability imposed by FINRA with adviser's fiduciary duty) ;
139. Koffler, supra note 9 (explaining that advisers have a duty to monitor; brokers duties cease with the purchase or sale).
140. See Black, supra note 21, at 36-37.
141. See SEC v. Pasternak, 561 F. Supp. 2d 459, 499 (D. N. J. 2008) ("[T]he Supreme Court of New Jersey would likely follow the weight of the authority to hold that a broker is in a fiduciary relationship with a client, where that client maintains an account with the broker in which the broker, not the client, retains discretion. ").
142. See, e.g.. Letter from Ira D. Hammerman, Senior Vice President & Gen. Counsel, Sec. Indus. & Fin. Mkts. Ass'n
143. to Jonathan G. Katz, Sec'y, U. S. Sec. & Exch. Comm'n 18 (Feb. 7, 2005), available at http://www.sec.gov/rules/proposed/s72599/sia020705.pdf [hereinafter 2005 Hammerman Letter] ("We submit that imposing unnecessarily burdensome regulation on principal transactions would be contrary to the interest of broker-dealer customers....").
144. See LOUIS LOSS & JOEL SELIGMAN, SECURITIES REGULATON 3972-76 (2004).
145. Investment Advisers Act § 206 (3), 15 U. S. C. § 80b-6 (3) (2006). The prohibition in section 206 (3) also applies where an affiliate or controlling person of the investment adviser acts as a principal when trading with the advisory client.
146. See LEMKE & LINS, supra note 75, § 2:30. Section 206 (3) also applies to dual registrants (firms registered as both broker-dealers and investment advisers) arranging cross trades between an advisory account and a non-advisory account. The SEC, however, has adopted Advisers Act Rule 206 (3)-2, 17 C. F. R. § 275.206 (3)-2 (2009), to provide relief to firms seeking to arrange these cross trades.
147. See LEMKE & LINS, supra note 75, § 2: 90.
148. Schenker Statement, supra note 62, at 322 ("[I]f a fellow feels he has a sour issue and finds a client to whom he can sell it, then that is not right.").
149. Opinion of Director of Trading and Exchange Division, Investment Advisers Act Release No. 40, 11 Fed. Reg. 10997 (Feb. 5, 1945) (stating that the requirements of disclosure and consent in section 206 (3) must be satisfied before each transaction).
150. See Letter from Ira D. Hammerman, Senior Managing Dir. & Gen. Counsel, Sec. Indus. & Fin. Mkts. Ass'n
151. to Robert E. Plaze, Assoc. Dir, Div of Inv Mgmt., U. S. Sec. & Exch. Comm'N.
152. and Catherine McGuire, Assoc. Dir. & Chief Counsel, Div of Mkt. Regulation, U. S. Sec. & Exch. Comm'n 21 (June 27, 2007), available at http://www.sec.gov/comments/s7-23-07/s72307-8.pdf;
153. see also Method for Compliance with Section 206 (3) of the Investment Advisers Act of 1940 with Respect to Certain Transactions, Exchange Act Release No. 13029, Advisers Act Release No. 557, 11 SEC Docket 1108 (Dec. 2, 1976).
154. See, e.g., 2005 Hammerman Letter, supra note 103, at 18.
155. 1999 Proposing Release
156. supra note 95, 64 Fed. Reg. 61226.
157. Id. at 61228.
158. Id. at 61229.
159. Id.
160. Id. at 61227 ("Until the Commission takes final action on the proposed rule, the Division of Investment Management will not recommend, based on the form of compensation received, that the Commission take any action against a broker-dealer for failure to treat any account over which the broker-dealer does not exercise investment discretion as subject to the Act.").
161. Reproposal, supra note 29, 70 Fed. Reg. at 2718.
162. Id.
163. Id. (explaining that commenters asserted that the rule would deny investors fiduciary and disclosure protections).
164. Id. ("Another theme among many opponents of the rule was the perceived competitive implications....").
165. Letter from Duane R. Thompson, Dir of Gov't Relations, Fin. Planning Ass'n
166. to Jonathan G. Katz, Sec'y U. S. Sec. & Exch. Comm'n (Jan. 14, 2000), available at www.sec.gov/rules/proposed/s72599/thompsol.htm.
167. Fin. Planning Ass'n v. SEC, 482 F.3d 481, 486 n. 5 (D. C. Cir 2007).
168. Reproposal, supra note 29, 70 Fed. Reg. 2716.
169. First, the SEC proposed to expand the disclosure to customers about the type of account they had, brokerage or advisory Second, the reproposal clarified conduct that would not be considered solely incidental to brokerage, such as rendering financial plaiming services. Third, the SEC added a provision interpreting the exercise of investment discretion as not solely incidental to brokerage.
170. Id. at 2723-29.
171. Adopting Release, supra note 16, 70 Fed. Reg. at 20427.
172. Id. at 20424
173. (to be codified at 17 C. F. R. § 275.202 (a) (11)-1).
174. Fin. Planning Ass'n, 482 F.3d 481.
175. Id. at 493.
176. See Interpretive Rule Under the Advisers Act Affecting Broker-Dealers, Advisers Act Release No. 2652, 72 Fed. Reg. 55126, 55127 (proposed Sept. 24, 2007) ("Though the Coun did not question the validity of our interpretive positions, it vacated the entire rule, leaving our interpretations potentially in doubt.").
177. Fin. Planning Ass'n, 482 F.3d at 487.
178. See 15 U. S. C. § 80b-2 (a) (11) (2006) ;
179. see also supra note 63 and accompanying text.
180. Investment Advisers Act § 202 (a) (11), 15 U. S. C. § 80b-2 (a) (11) (2006).
181. Id. § 202 (a) (11) (G), 15 U. S. C. § 80b-2 (a) (11) (G) (2006). Subsection (F) was redesignated (G) in the Credit Rating Agency Reform Act of 2006, Pub. L. No. 109-291, § 4 (b),
182. 120 Stat. 1327, 1337.
183. For consistency with the Financial Planning Association decision, this Article continues to refer to subsection (F).
184. Fin. Planning Ass'n, 482 F.3d at 488.
185. Id.
186. Id. at 489, 494.
187. Id. at 488-89.
188. See id. at 489;
189. see also Brief of Petitioner at 31-34
190. Fin. Planning Ass'n v. SEC, 482 F.3d 481 (D. C. Cir 2007) (Nos. 04-1242, 05-1145).
191. WL 1908659.
192. Fin. Planning Ass'n, 482 F.3d at 488.
193. Id.
194. Id. at 488-90.
195. Id. at 488 ("By seeking to exempt broker-dealers beyond those who receive only brokerage commissions for investment advice, the SEC has promulgated a final rule that is in direct conflict with both the statutory text and the Committee Reports.").
196. 467 U. S. 837 (1984). Under step one, a court must determine whether Congress has spoken to the precise question at issue. If yes, that ends the inquiry The court and the agency must give effect to the will of Congress. If not, the court must determine if the agency's answer is based on a permissible construction of the relevant statute.
197. Id. at 842-43.
198. Fin. Planning Ass'n, 482 F.3d at 492. The SEC also invoked its statutory authority under section 211 (a), which provides authority to issue rules "necessary or appropriate" to the exercise of the functions and powers conferred on the Commission and to "classify persons and matters within its jurisdiction and prescribe different requirements for different classes of persons or matters." Investment Advisers Act § 211 (a)
199. U. S. C. § 80b-11 (a) (2006). The court, however, stated that this provision was unavailing because the SEC could not ignore the will of Congress.
200. Fin. Planning Ass'n, 482 F.3d at 493.
201. Fin. Planning Ass'n, 482 F.3d at 495 (Garland, J., dissenting).
202. U. S. Sec. & Exch. Comm'N.
203. Commission Seeks Time for Investors and Brokers to Respond to Court Decision on Fee-Based Accounts, SEC NEWS DIGEST, May 14, 2007, www.sec.gov/news/digest/2007/dig051407.txt [hereinafter SEC, Commission Seeks Time] ("In asking for a 120-day stay of the ruling of the U. S. Court of Appeals for the District of Columbia Circuit in Financial Planning Association v. SEC, the Commission announced it will not seek further review of the March 30, 2007 decision....").
204. Temporaiy Rule Regarding Principal Trades with Certain Advisory Clients, Advisers Act Release No. 2653, 72 Fed. Reg. 55022, 55022 (Sept. 27, 2007) [hereinafter Temporary Rule Release).
205. Fin. Planning Ass'n v. SEC, Nos. 04-1242 & 05-1145, 2007 U. S. App. LEXIS 15169 (D. C. Cir June 25, 2007) (order granting respondent's motion to stay mandate).
206. See, e.g., Stuart Kaswell, Jack Murphy, Jane Kanter, Alan Rosenblat, Michael Sherman & Lisa Price, SEC Not to Appeal Decision Vacating Broker-Dealer Exemption Rule, DECHERT ON POINT (Dechert LLP), May 2007, at 6, available at http://www.dechert.com/library/FS-14-05-07-SEC-Will-Not-Appeal- Decision. pdf.
207. Temporary Rule Release, supra note 145, 72 Fed. Reg. at 55024.
208. See, e.g., Walter Speech, supra note 9.
209. In an interesting twist, the substance-over-form argument can be used to argue both for and against treating brokers that give advice as advisers. On the one hand, if brokers are engaged in advisory services, then placing substance over form would favor treating brokers as advisers. On the other hand, if brokers have not changed their function over the past several years and only their labels and compensation structure have changed, then there is no reason to alter their regulation. Indeed, one impetus behind the SECs adoption of Rule 202 (a) (11)-1 was the notion that brokers have not changed their business model, only their form of compensation.
210. See Adopting Release, supra note 16, 70 Fed. Reg. at 20426. As a result, their regulation should not change either.
211. See supra note 69 and accompanying text.
212. See RAND REPORT, supra note 12, at 74 (stating that typical job titles of employees in brokerage firms include financial advisor, financial consultant, financial representative, and investment specialist).
213. See supra notes 103-07 and accompanying text.
214. Investment Advisers Act § 203 (b) (3), 15 U. S. C. § 80b-3 (b) (3) (2006).
215. RESTATEMENT (THIRD) OF AGENCY § 1.01 (2006).
216. See id. cmt. e.
217. Adopting Release, supra note 16, 70 Fed. Reg. at 20442.
218. See RAND REPORT, supra note 12.
219. Id. at 90 ("Respondents [of the survey] tended to believe that financial advisors and consultants are more similar to investment advisers than to brokers in terms of the services provided, compensation methods, and duties.").
220. 334 F.3d 1183 (10th Cir. 2003).
221. Id. at 1186-87. In a wrap fee program, a sponsor arranges for several services such as portfolio management, brokerage execution, clearing, custody, and other administrative services to be provided to an investor for a single fee, called a wrap fee.
222. See Michael B. Koffler, Wrap Fee Programs: New Challenges in a Familiar Framework, in INVESTMENT ADVISER REGULATION 325 (ALI-ABA Course of Study, Jan. 26, 2007) (available on Westlaw at SM064 ALI-ABA 325).
223. Geman, 334 F.3d at 1186.
224. Id. The promotional literature read: "As an independent fiduciary, PMC is dedicated to providing the independent advisory and administrative services necessary to support you in meeting your unique and specialized goals and objectives."
225. Id.
226. Id.
227. Id. at 1187.
228. Id. at 1189.
229. Id.
230. Id.
231. See supra note 112 and accompanying text.
232. Adopting Release, supra note 16, 70 Fed. Reg. at 20434-36.
233. 1999 Proposing Release, supra note 95, 64 Fed. Reg. at 61229.
234. Id. ("[S]ome broker-dealers offering these new accounts have heavily marketed them based on the advisory services provided rather than the execution services, which raises troubling questions as to whether the advisory services are not (or will be perceived by investors not to be) incidental to the brokerage services.").
235. Adopting Release, supra note 16, 70 Fed. Reg. at 20435.
236. See Investment Advisers Act § 202 (a) (11) (B), 15 U. S. C. § 80b-2 (a) (11) (B) (2006) ;
237. see also supra notes 74-75 and accompanying text.
238. * 1 (May 7, 1984) (stating that relevant factors are whether the professional holds himself out as an adviser, whether advice is related to other services provided, and whether a separate fee structure exists for advisory services).
239. See id.
240. See RAND REPORT, supra note 12, at 104-05. RAND asked respondents what kind of professional services with regard to financial matters they would find most helpful. Possible responses were "asset management, college-saving planning, debt consolidation or management, developing a budget and saving plan, estate planning, executing stock or mutual fund transactions, general financial planning, investment advising, retirement planning, or other."
241. Id. at 104. The top answers were retirement planning, investment advising, financial planning, and estate planning.
242. Id. at 104-05.
243. Congress could leave the broker-dealer exclusion in place but revise the text so that a broker would be excluded from the Advisers Act so long as the advice was solely incidental to brokerage. This would permit brokers to take advantage of the exclusion and still charge an asset-based fee.
244. See Terri Cullen, As Schwab Returns to Its Discount Roots, Small Investors Face Shifting Choices, WALL ST. J., Aug. 4, 2004, at D1 ("[I]nvestors will see a shift away from commissions to asset-based fees-and that ultimately may make it harder for investors to know exactly what they're paying for.").
245. See supra notes 33-45 and accompanying text.
246. TWENTIETH CENTURY FUND, supra note 31, at 231.
247. Id. at 649-50.
248. See NASD R. 2310 (1996).
249. 306 F.3d 1293, 1302 (2d Cir. 2002).
250. In a wrap fee program, broker-dealers often act as the sponsors. See Adopting Release, supra note 1.6, 70 Fed. Reg. at 20441. And the sponsor generally is responsible for ongoing monitoring of the management of the account by the advisers selected by the sponsor.
251. See Status of Investment Advisory Programs Under the Investment Company Act of 1940, Advisers Act Release No. 1623, 62 Fed. Reg. 15098, 15099 (Mar. 24, 1997).
252. See SEC v. Capital Gains Research Bureau, Inc., 375 U. S. 180, 187 (1963) (describing the advisory function as providing "continuous advice"
253. (quoting H. R. Doc. No. 76-477, supra note 41, at 28 n. 43)).
254. Koffler, supra note 9, at 6 n. 30.
255. Note, The Role of Prepaid Group Practice in Relieving the Medical Care Crisis, 84 HARV. L. REV. 887, 900 (1971).
256. Id. at 903-05.
257. * 5 (Mo. Ct. App. Apr. 25, 1989) ("A subscriber to Total Health Care, or to any other prepaid medical services plan, expects and assumes that the plan will cover the expenses of medical care.") ;
258. Edward Hirshfeld, The Case for Physician Direction in Health Plans, 3 ANNALS HEALTH L. 81, 85 (1994) (under capitation, "providers are paid a set amount per patient for a period of time, and are expected to provide all necessary services (as defined in the provider contract) to a specific patient population") ;
259. Chris Rauber, Decapitating Managed-Care Contracts: Some Providers Say Global Capitation Has Tied a Noose Around Their Finances, MOD. HEALTHCARE, Sept. 6, 1999, at 52, 52 (capitation payments are "expected to cover any and all healthcare services provided by a hospital, physicians and ancillary services").
260. TULLY REPORT, supra note 90, at 10.
261. Id.
262. See supra notes 72-75 and accompanying text.
263. Adopting Release, supra note 16, 70 Fed. Reg. at 20436 n. 135.
264. Id.
265. WEBSTERS NEW INTERNATIONAL DICTIONARY OF THE ENGLISH LANGUAGE 1257 (2d ed. 1938) ("Happening as a chance or undersigned feature of something else; casual; hence, not of prime concern; subordinate.") ;
266. WEBSTER'S COLLEGIATE DICTIONARY 506 (5th ed. 1938) ("Happening as a chance or undersigned feature of something else; casual; hence, minor; of secondary importance.") ;
267. NEW STANDARD DICTIONARY OF THE ENGLISH LANGUAGE 1242 (1935) ("Occurring in the course of or coming as a result or an adjunct of something else; concomitant.... Happening or coming without regularity or design; foreign or subordinate to the general purpose.") ;
268. THE WINSTON SIMPLIFIED DICTIONARY 287 (1929) ("[C]asual, liable to happen unexpectedly; happening as a chance feature of something else... something casual or subordinate.") ;
269. THE NEW CENTURY DICTIONARY OF THE ENGUSH LANGUAGE 809 (1927) ("Occurring or liable to occur in connection with something else; happening in fortuitous or subordinate conjunction with something else; casual or accidental; often, incurred casually and in addition to the regular or main amount.").
270. WEBSTER'S NEW INTERNATIONAL DICTIONARY OF THE ENGUSH LANGUAGE, supra note 196, at 1257.
271. BLACK'S LAW DICTIONARY 942-43 (3d ed. 1933).
272. RICHARD SOULE, A DICTIONARY OF ENGLISH SYNONYMS AND SYNONYMOUS EXPRESSIONS 280 (1938).
273. Adopting Release, supra note 16, 70 Fed. Reg. at 20436 & n. 134
274. (quoting U. S. SEC. & EXCH. COMM'N, SEVENTH ANNUAL REPORT OF THE SECURITIES AND EXCHANGE COMMISSION (1941), available at http://c0403731.cdn. cloudfiles.rackspacecloud.com/collection/papers/1940/1941-SEC-AR.pdf).
275. See, e.g.. Letter from Duane R. Thompson, Group Dir., Advocacy, Fin. Planning Ass'n, to Jonathan G. Katz, Sec'y, U. S. Sec. & Exch. Comm'n 10-11 (Feb. 7, 2005), available at http://www.sec. gov/rules/proposed/s72599/ fpa020705.pdf (pointing to definitions of incidental as unpredictable or minor) ;
276. Letter from Barbara Roper, Dir. of Investor Prot., Consumer Fed'n of Am., to Jonathan G. Katz, Sec'y, U. S. Sec. & Exch. Comm'n 9 (Feb. 7, 2005), available at http://www.sec.gov/rules/proposed/s72599/s72599-1746.pdf (stating that the SEC ignores the "minor or secondary" aspect of the term "solely incidental to") ;
277. Letter from Mercer Bullard, Founder & President, Fund Democracy, et al. to Jonathan G. Katz, Sec'y, U. S. Sec. & Exch. Comm'n 4 (Feb. 7, 2005), available at http://www.sec. gov/rules/proposed/s72599/s72599-1745.pdf (arguing that even under the SEC's definitions, "solely incidental to" requires that brokerage be primary and advice resulting as a consequence of specific brokerage transactions).
278. CHARLES F. HODGES, WALL STREET 20 (1930).
279. Id.
280. Id.
281. Id.
282. Id.
283. Id.
284. Id. at 20-21.
285. 1 WILLIAM HARMAN BUCK, THE LAW OF STOCK EXCHANGES, STOCKBROKERS & CUSTOMERS 79 (1940).
286. Id.
287. See id.;
288. see also Fairbaim v. Rausch, 93 N. Y. S. 666, 669 (App. DIV. 1905).
289. HODGES, supra note 202, at 21.
290. Id.
291. Id. at 23-24.
292. Id. at 24.
293. See, e.g., Batterson v. Raymond, 149 N. Y. S. 706, 711 (Sup. Ct. 1914) ;
294. Haight v. Haight & Freese Co., 92 N. Y. S. 934, 936 (Sup. Ct. 1905) ;
295. Wahl v. Tracy, 121 N. W 660, 661 (Wis. 1909).
296. BLACK, supra note 209, at 211-12.
297. Cases and commentators generally state that brokers typically are not subject to fiduciary duties unless they have investment discretion over an account. See supra notes 100-02 and accompanying text. Some courts, however, disagree, stating explicitly that this perception is erroneous.
298. * 2 (S. D. N. Y. May 5, 2008) ("The essence of the argument is that there is no fiduciary relation between a broker and a customer unless the broker is handling a discretionary account. That is simply not true."). Similarly, California and other state courts hold that brokers generally are fiduciaries.
299. See, e.g., Duffy v. Cavalier, 264 Cal. Rptr. 740, 751 (Ct. App. 1989) ("[T) he relationship between a stockbroker and his or her customer is fiduciary in nature; the distinction between a 'sophisticated' investor and an 'unsophisticated' one is not controlling in this regard.").
300. Michael J. Simon & Robert L. D. Colby, The National Market System for Over-the-Counter Stocks, 55 GEO. WASH. L. REV. 17, 34-38 (1986).
301. See Jerry W Markham & Daniel J. Harty, For Whom the Bell Tolls: The Demise of Exchange Trading Floors and the Growth of ECNs, 33 J. CORP. L. 865, 897 (2008).
302. Id. at 897-98.
303. See Roberta S. Karmel, Should Securities Industry Self-Regulatory Organizations Be Considered Government Agencies?, 14 STAN. J. L. BUS. & FIN. 151, 161 (2008).
304. JOHN BROOKS, THE GO-GO YEARS 22 (1973).
305. Id.
306. Markham & Harty, supra note 220, at 902.
307. Id. at 899.
308. Id.
309. Id. at 902.
310. See id.
311. See also INTERACTIVE BROKERS, INTERACTIVE BROKERS QUARTERLY ORDER ROUTING REPORT, QUARTER ENDING MARCH 31, 2009, at 1 (2009), available at http://www.interactivebrokers.com/downloao/lQ-2009-IB-ORDER-ROUTING-REPORT.pdf. When a customer places a limit order, he "takes liquidity" imposing a cost; when he places a market order, he "provides liquidity" reducing costs and allowing rebates.
312. See id.
313. See generally Markham & Harty, supra note 220.
314. Id. at 904-05.
315. Interactive Brokers, Commissions, Stocks, ETFs and Warrants/Bundled North America, http://www.interactivebrokers.com/en/accounts/fees/commission. php (last visited Dec. 15, 2009).
316. Firms offering no-commission brokerage rely solely on advertising for revenue. Ravi Kalakota & Benn Konsynski, The Rise of Neo-Intermediation: The Transformation of the Brokerage Industry, 2 INFO. SYS. FRONTIERS 115, 118 (2000) ;
317. JP Whickson, No Commission Stock Trading Accounts, ASSOCIATED CONTENT, Dec. 15, 2008, http://www.associatedcontent.com/article/1273048/no-commission- stock-trading-accounts.html?cat=3;
318. Cassell Bryan-Low, Web Brokers Begin to Offer No-Commission Stock Trades, WALL ST. J., June 19, 2000, at Cl.
319. See TULLY REPORT, supra note 90, at 3 ("The most important role of the registered representative is, after all, to provide investment counsel to individual clients.") ;
320. see also Press Release, U. S. Sec. & Exch. Comm'n, SEC Charges Ameriprise in Fraudulent Scheme to Obtain Undisclosed Compensation (July 10, 2009), www.sec.gov/news/press/2009/2009-155.htm ("Few things are more important to investors than getting unbiased advice from their financial advisers."
321. (quoting Robert Khuzami, Dir., Div. of Enforcement, U. S. Sec. & Exch. Comm'n)).
322. See supra notes 64-65 and accompanying text.
323. TREASURY WHITE PAPER, supra note 6, at 71.
324. See Koffler, supra note 9, at 4.
325. See LOUIS LOSS & JOEL SELIGMAN, SECURITIES REGULATION 1206-08 (2007).
326. See 15 DAVID A. LIPTON, BROKER-DEALER REGULATION § 3.3 (2009).
327. See TREASURY WHITE PAPER, supra note 6, at 71;
328. see also H. R. 4173, supra note 7, § 7103;
329. SENATE DRAFT LANGUAGE, supra note 8, § 913.
330. TREASURY WHITE PAPER, supra note 6, at 71.
331. COX, HILLMAN & LANGEVOORT, supra note 36, at 1029.
332. See THOMAS LEE HAZEN, THE LAW OF SECURITIES REGULATION § 14.14 [3] (A] (rev. 5th ed. 2006).
333. See NORMAN S. POSER, BROKER-DEALER LAW AND REGULATION 31-38 (1995) (reviewing potential conflicts of interest in financial firm performing multiple functions).
334. See, e.g., SEC v. Tambone, 550 F.3d 106, 146 (1st Cir. 2008) ("Section 206 imposes a fiduciary duty on investment advisers to act at all times in the best interest of the fund and its investors...."), reh'g granted & opinion withdrawn,
335. 573 F.3d 54 (1st Cir. 2009).
336. U. S. DEP'T OF THE TREASURY, TITLE IX-ADDITIONAL IMPROVEMENTS TO FINANCIAL MARKETS REGULATION § 913 (July 16, 2009), available at http://www.treas.gov/press/releases/docs/tg205071009.pdf.
337. Schapiro Statement, supra note 9, at 13 ("I support the standard contained in the bill Treasury recently put forth, which would require broker-dealers and investment advisers to act solely in the interests of their customers or clients when providing investment advice.").
338. GEORGE GLEASON BOGERT, GEORGE TAYLOR BOGERT & AMY MORRIS HESS, THE LAW OF TRUSTS AND TRUSTEES § 543 (2d ed. 1993 & Supp. 2009).
339. See, e.g., John T. Flynn, Other People's Money: Contradictory Recommendations of the S. E. C-Are Brokers and Traders to Be Separated?-Let the S. E. C. Protect the Public, NEW REPUBLIC, Jan. 8, 1936, at 253.
340. H. R. 7852, 73d Cong. § 10 (1934) ;
341. S. 2693, 73d Cong. § 10 (1934).
342. Flynn, supra note 249, at 253 ("[N]o man whose primary function is a fiduciary one-Lhat of an agent-should be permitted to enter the market in which he appears as an agent for others and to trade in that market for himself.").
343. S. REP. No. 73-1455, at 29-30 (1934).
344. See SEGREGATION REPORT, supra note 30;
345. for a discussion, see SELIGMAN, supra note 53, at 144-49.
346. SELIGMAN, supra note 53, at 146.
347. See SEGREGATION REPORT, supra note 30, at 109;
348. U. S. SEC. & EXCH. COMM'N, SECOND ANNUAL REPORT OF THE SECURITIES AND EXCHANGE COMMISSION 23 (1936), available at http://c0403731.cdn. cloudfiles. rackspacecloud.com/collection/papers/1930/1936-SEC-AR.pdf;
349. see also SELIGMAN, supra note 53, at 148-49.
350. John T. Flynn, The S. E. C. Unmasks the Brokers, NEW REPUBLIC, July 8, 1936, at 260.
351. Id. at 261.
352. In a series of cases, the SEC held that when a firm transacts as a dealer, it nevertheless undertakes to act on the customer's behalf. The theory was affirmed in Charles Hughes & Co. v. SEC, 139 F.2d 434 (2d Cir. 1943)
353. cert. denied, 321 U. S. 786 (1944). The approach was called the "shingle" theory since the firm had hung out its shingle and thereby offered to act on the customers behalf and subject itself to enhanced duties.
354. The determination of whether prices are substantially below or above market could only be made on a case-by-case basis. In re Duker & Duker, Exchange Act Release No. 2350, 6 S. E. C. 386, 389 (1939).
355. Id. (dealer must charge price "which bears a reasonable relation to the prevailing price" or disclose information to allow the customer to make an informed decision with regard to the transaction).
356. See, e.g., Burdett v. Miller, 957 F.2d 1375, 1381 (7th Cir. 1992) ("A fiduciary duty is the duty of an agent to treat his principal with the utmost candor, rectitude, care, loyalty, and good faith-in fact to treat the principal as well as the agent would treat himself.") ;
357. United States v. Dial, 757 F.2d 163, 168 (7th Cir. 1985) ("The essence of a fiduciary relationship is that the fiduciary agrees to act as his principals alter ego....").
358. One might respond by stating that a dealer's mark-up or mark-down is nothing more than a fee paid by a customer to buy or sell a security. This definition is consistent with common usage of the term. See Amendments to Regulation SHO, Exchange Act Release No. 59748, 74 Fed. Reg. 18042, 18058 (proposed Apr. 10, 2009) (to be codified at 17 C. F. R. pt. 242).
359. Charging a fee is not prohibited under a "best interest analysis." Trustees, which owe strong fiduciary duties to trust beneficiaries, are permitted to charge a fee to administer a trust. MARY E RADFORD, GEORGE GLEASON BOGERT & GEORGE TAYLOR BOGERT, THE LAW OF TRUSTS AND TRUSTEES § 975, at 3 (3d ed. 2006 & Supp. 2009) ("For some time a trustee has been allowed compensation in the United States."). A principal trade, therefore, is arguably akin to charging a fee and consistent with ones fiduciary duty. A mark-up or mark-down, however, is a unique type of fee; it is structurally different from a stated commission or asset-based fee. It is less transparent because it is built into the purchase or sale price of the security, and it is less likely to be separately analyzed by an investor, even if disclosed. Perhaps this explains the rules and interpretations imposed by FINRA with respect to limitations on mark-ups and mark-downs.
360. See FINRA IM-2440-1: MARK-UP POLICY (2008), available at http://finra.complinet.com/en/display/display.html?rbid=2403&record-id= 4338&element-id=3661&highlight=IM-2440-l#r4338 (reaffirming 5 percent policy as a guide to determining what constitutes an unreasonable mark-up).
361. See LOSS & SELIGMAN, supra note 238, at 492-524.
362. HAZEN, supra note 243, § 2.1 [2] [6]. Participating dealers are not in privity with the issuer. They purchase from the lead underwriter or underwriters and sell to their own customers, pocketing the spread between what they pay for the shares and the sale price to investors. They are not subject to underwriter liability, but face liability under other provisions of the federal securities laws.
363. MARC I. STEINBERG, SECURITIES REGULATION 190 (5th ed. 2008). Although not underwriters, they face the same pressures to sell the shares to avoid holding the securities on their own books and to demonstrate to the market that they are successful participants in the deal.
364. Cf. COX, HILLMAN & LANGEVOORT, supra note 36, at 119.
365. For an overview, see National Association of Securities Dealers, Inc.; Order Approving Proposed Rule Change, Exchange Act Release No. 17371, 45 Fed. Reg. 83707, 83709 (Dec. 19, 1980) ;
366. STEINBERG, supra note 264, at 189.
367. H. R. Doc. No. 88-95, pt. 1, at 439 (1963) (explaining that multiple functions such as underwriting and brokerage lead to conflicts because each function entails separate obligations to particular persons).
368. See HAZEN, supra note 243, § 14.12.
369. See id. (discussing conflicts inherent in multi-service firms).
370. In a firm commitment underwriting, unsold shares remain in the firms inventory and may be sold at a loss. In a best efforts underwriting, the firm may receive a fee only if all or a requisite number of the shares are sold. See COX, HILLMAN & LANGEVOORT, supra note 36, at 120.
371. See Billings v. Credit Suisse First Boston Ltd., 426 F.3d 130, 139 (2d Cir. 2005) ("Underwriters have strong incentives to manipulate the IPO process to facilitate the complete distribution and sale of an issue. Underwriting is a business; competitive forces dictate that underwriters associated with successful IPOs will attract future issuers.")
372. rev'd, 551 U. S. 264 (2007) ;
373. COX, HILLMAN & LANGEVOORT, supra note 36, at 119.
374. Temporary Rule Release, supra note 145, 72 Fed. Reg. at 55027 ("[T]he broker-dealer's incentives to 'dump' securities it is underwriting are greater for sales by a broker-dealer acting as an underwriter than for sales by a broker-dealer not acting as an underwriter of other securities from its inventory").
375. See supra notes 103-07 and accompanying text.
376. Temporary Rule Release, supra note 145, 72 Fed. Reg. at 55022.
377. Id. at 55023.
378. Id. at 55028. The SEC has extended the expiration date on the temporary rule until December 31, 2010.
379. Temporary Rule Regarding Principal Trades with Certain Advisory Clients, Advisers Act Release No. 2965, 74 Fed. Reg. 69009 (Dec. 30, 2009) (to be codified at 17 C. F. R. pt. 275).
380. See U. S. SEC. & EXCH. COMM'N, DISCLOSURE TO INVESTORS: A REAPPRAISAL OF FEDERAL ADMINISTRATIVE POLICIES UNDER THE '33 AND '34 ACTS 52 (1969), available at http://www.sechistorical.org/museurn/papers/1960/("[D] isclosures reach average investors through a process of fitration in which intermediaries (brokers, bankers, investment advisers, publishers of investment advisory literature, and occasionally lawyers) play a vital role.") ;
381. see also Steven L. Schwarcz, Rethinking the Disclosure Paradigm in a World of Complexity, 2004 U. ILL. L. REV. 1, 7-17 (discussing challenges of disclosure as a regulatory model in light of transaction complexity).
382. Daylian M. Cain, George Loewenstein & Don A. Moore, Coming Clean but Playing Dirtier: The Shortcomings of Disclosure as a Solution to Conflicts of Interest, in CONFLICTS OF INTEREST: CHALLENGES AND SOLUTIONS IN BUSINESS, LAW, MEDICINE, AND PUBLIC POLICY 104, 109 (Don A. Moore, Daylian M. Cain, George Loewenstein & Max H. Bazerman eds., 2005).
383. Id.
384. See, e.g., Daniel Kahneman, Ilana Ritov & David Schkade, Economic Preferences or Attitude Expressions? An Analysis of Dollar Responses to Public Issues, in CHOICES, VALUES, AND FRAMES 642, 665-66 (Daniel Kahneman & Amos Tversky eds., 2000) ("Tasks in which respondents indicate a judgment or an attitude by producing a number are susceptible to an anchoring effect: the response is strongly biased toward any value, even if it is arbitrary, that the respondent is induced to consider as a candidate answer." (emphasis omitted)).
385. See U. S. Securities and Exchange Commission, The Investors Advocate: How the SEC Protects Investors, Maintains Market Integrity, and Facilitates Capital Formation, http://www.sec.gov/about/whatwedo.shtml (last visited Dec. 15, 2009). Disclosure as a mechanism to address information asymmetries has come under attack as transactions become more complex.
386. See Schwarcz, supra note 276, at 11-17.
387. Daylian M. Cain, George Loewenstein & Don A. Moore, The Dirt on Coming Clean: Perverse Effects of Disclosing Conflicts of Interest, 34 J. LEGAL STUD. 1, 7 (2005). The study authors have provided two possible explanations for this result. The first, strategic exaggeration, occurs where the advisor, knowing that disclosure might cause her advice to be discounted, will try to counteract that effect by skewing the advice even further. (Pubitemid 40549835)
388. Id. The second, moral licensing, occurs when disclosure is perceived to level the playing field and, consequently, the adviser may feel less obliged to worry about the interests of the recipient and, instead, pay more attention to her own self-interest.
389. Id.
390. See Paul E Roye, Dir., Div. of Inv. Mgmt., U. S. Sec. & Exch. Comm'n, Remarks Before the Investment Council Association of America: Meeting the Compliance Challenge (Apr. 23, 1999) (transcript available at www.404.gov/news/speech/speecharchive/1999/spch271.htm) ;
391. Paul F. Roye, Dir., Div. of Inv. Mgmt., U. S. Sec. & Exch. Comm'n, Remarks Before the IA Compliance Summit and Best Practices Update: Priorities in Investment Adviser Regulation (Apr. 8, 2002) (transcript available at www.sec.gov/news/speech/spch549.htm).
392. Letter from Nora M. Jordan, Yukako Kawata, Leor Landa, Danforth Townley & John G. Crowley, Davis Polk & Wardwell LLP, to Nancy M. Morris, Sec'y, U. S. Sec. & Exch. Comm'n 3 (Dec. 4, 2007), available at http://www.sec.gov/comments/s7-23-07/s72307-19.pdf [hereinafter Jordan Letter].
393. * 1 (1984).
394. Investment Advisers Act Rule 204-2, 17 C. F. R. § 275.204-2 (2009) (setting forth books and records to be retained by advisers) ;
395. Securities Exchange Act Rules 17a-3, 17a-4, 17 C. F. R. §§ 240. 17a-3, 240.17a-4 (2009) (setting forth books and records to be retained by broker-dealers).
396. Jordan Letter, supra note 283, at 3-4.
397. Id.
398. See LOSS & SELIGMAN, supra note 238, at 3834-43. Under this approach, a dealer still could hold securities that do not qualify as highly liquid, but it could not sell those securities to its own customers. Presumably the firms would establish information barriers separating the desk investing in illiquid securities and the persons dealing with customers.
399. COX, HILLMAN & LANGEVOORT, supra note 36, at 115.
400. See Securities Offering Reform, Securities Act Release No. 8591, 70 Fed. Reg. 44722, 44728 (Aug. 3, 2005).
401. THOMAS LEE HAZEN, 1 LAW OF SECURITIES REGULATION § 4.24 (6th ed. 2009) (describing institutional investors as "sufficiently sophisticated" and with "sufficiently strong bargaining positions so as not to need the protections of federal registration"). One should be careful not to overstate this point because sales to omnibus accounts controlled by advisers might be deemed sales to institutional investors. In that case, however, the adviser should have sufficient expertise to evaluate the transaction on a clients behalf.
402. See JOHN C. COFFEE, JR., GATEKEEPERS: THE PROFESSIONS AND CORPORATE GOVERNANCE 4 (2006) (discussing role of gatekeepers, such as auditors, attorneys, and investment bankers, and highlighting reputational capital that would be lost if they condoned wrongdoing).
403. Arthur B. Laby, Resolving Conflicts of Duty in Fiduciary Relationships, 54 AM. U. L. REV. 75, 77-78 (2004) (arguing that when faced with a conflict of duties, courts resolve it in favor of the negative duty of loyalty representing minimum conduct to which the fiduciary must adhere as opposed to the positive duty of care, which is an open-ended duty to benefit the principal).
404. See The Hippocratic Oath, National Library of Medicine, National Institutes of Health, www.nlm.nih.gov/hmd/greek/greek-oath.html (last visited Dec. 15, 2009).
405. 332 F. Supp. 544 (E. D. N. Y. 1971).
406. Id. at 581.
407. * 13 (Del. Ch. Aug. 27, 2004) (holding that issuer sufficiently alleged fiduciary relationship with defendant underwriters) ;
408. EBCI, Inc. v. Goldman Sachs & Co., 832 N. E.2d 26, 31-33 (N. Y. 2005) (although underwriting agreement for an IPO did not itself create fiduciary duty, advisory relationship between underwriter and issuer was marked by trust and confidence and was fiduciary).
409. Cf. James Fanto, The Continuing Need for Broker-Dealer Professionalism in IPOs, 2 ENTREPRENEURIAL BUS. L. J. 679, 692-93 (2008) (recommending a QIU in the IPO context).
410. NASD R. 2720 (2009) ;
411. see also 24 WILLIAM M. PRIFTI, SECURITIES: PUBLIC AND PRIVATE OFFERINGS § 5: 25 (2d ed. 2009).
412. Id.
413. 17 J. WILLIAM HICKS, CIVIL LIABILITIES: ENFORCEMENT AND LITIGATION UNDER THE 1933 ACT § 4: 34 (2009).
414. NASD R. 2720 (a) (1) (2009).
415. See PRIFTI, supra note 299, § 5: 25.
416. Compliance Program of Investment Companies and Investment Advisers, Investment Company Act Release No. 25925, 68 Fed. Reg. 7038, 7039 (proposed Feb. 11, 2003) ("Our current resources permit us to conduct routine examinations of each of the 966 fund complexes and each adviser only once every five years, and during these examinations we are unable to review every transaction. ").
417. See Posner, supra note 20.
418. SEC, Commission Seeks Time, supra note 144.
419. Pub. L. No. 104-290, 110 Stat. 3416 (codified in scattered sections of 15 U. S. C.).
420. Id. § 303, 15 U. S. C. § 80b-3a (2006) (adding section 203A to the Investment Advisers Act of 1940).
421. Id., 15 U. S. C. § 80b-3a (a) (l) (A) (2006).
422. When proposing the hedge fund adviser rules, the Commission noted the extra burden the requirement would place on the agency and suggested it could increase the threshold for SEC registration to reduce the number of registered advisers. Registration Under the Advisers Act of Certain Hedge Fund Advisers, Advisers Act Release No. 2266, 69 Fed. Reg. 45172, 45190 (proposed July 28, 2004).
423. Enhancing Investor Protection and the Regulation of Securities Markets, Hearings Before the S. Comm. on Banking, Housing, and Urban Affairs, 111th Cong. 9 (2009) (testimony of Fred J. Joseph, Colo. Sec. Comm'r and President, N. Am. Sec. Adm'rs Ass'n, Inc.), available at http://banking. senate.gov/public/index. cfm?FuseAction=Hearings. Testimony&Hearing-lD=081fbcf6-953b-4701-ba03- e354ec6e8514&Witness-ID=cb02c45b-cfa2-4ae4-a47f-0eeabd7e2d62.
424. Id.
425. Investment Advisers Act § 203A (b) (1), 15 U. S. C. § 80b-3a (b) (1) (2006).
426. 15 U. S. C. § 80b-2 (a) (2006).
427. Investment Advisers Act § 206, 15 U. S. C. § 80b-6 (2006).
428. See, e.g.. Investment Advisers Act § 204, 15 U. S. C. § 80b-4 (2006) (requiring advisers, other than those exempt from registration, to keep certain books and records) ;
429. Investment Advisers Act § 204A, 15 U. S. C. § 80b-4a (2006) (requiring advisers, other than those exempt from registration, to establish, maintain, and enforce insider trading policies and procedures) ;
430. Investment Advisers Act § 208, 15 U. S. C. § 80b-8 (2006) (prohibiting advisers registered with the SEC from claiming that their qualifications have been passed on by the United States).
431. See, e.g., Investment Advisers Act Rule 204A-1, 17 C. F. R. § 275. 204A-1 (2009) (requiring an adviser registered or required to be registered to prepare a code of ethics) ;
432. Investment Advisers Act Rule 206 (4)-1, 17 C. F. R. § 275. 206 (4)-1 (2009) (prohibiting any adviser registered or required to be registered from making certain advertisements) ;
433. Investment Advisers Act Rule 206 (4)-2, 17 C. F. R. § 275. 206 (4)-2 (2009) (establishing custody rules for advisers registered or required to be registered) ;
434. Investment Advisers Act Rule 206 (4)-7, 17 C. F. R. § 275. 206 (4)-7 (2009) (requiring any adviser registered or required to be registered to adopt and implement compliance policies and procedures).
435. Investment Advisers Act § 203 (b), 15 U. S. C. § 80b-3 (b) (2006).
436. Transamerica Mortgage Advisors, Inc. (TAMA) v. Lewis, 444 U. S. 11, 24 (1979).
437. LEMKE & LINS, supra note 75, § 2.113 ("[C]oncern has been expressed that wrap fees may give rise to 'reverse churning' (i.e., a lack of trades in an account that otherwise would have been made had the client been paying separate commissions for them).")
438. See Neil H. Aronson, Preventing Future Enrons: Implementing the Sarbanes-Oxley Act of 2002, 8 STAN. J. L. BUS. & FIN. 127, 128 (2002) ("Americans demanded greater accountability from public companies and their auditors. The resultant Sarbanes-Oxley Act of 2002 was quickly enacted in July 2002 to calm troubled markets, restore investor confidence, and minimize the chances of future Enrons.") ;
439. Lawrence A. Cunningham, The Sarbanes-Oxley Yawn: Heavy Rhetoric, Light Reform (and It Just Might Work), 35 CONN. L. REV. 915, 927-28 (2003) (explaining that the Sarbanes-Oxley Act was "the product of Congressional hearings conducted throughout the period following Enrons first sordid revelations, and gaining momentum rapidly in the weeks before enactment in late July").
440. See Lawrence A. Cunningham, From Random Walks to Chaotic Crashes: The Linear Genealogy of the Efficient Capital Market Hypothesis, 62 GEO. WASH. L. REV. 546, 598 (1994) ("In the wake of the 1987 market crash, the major national securities exchanges adopted circuit breakers to forfend future crashes.") ;
441. Theresa A. Gabaldon, The Role of law in Managing Market Moods: The Whole Story of Jason, Who Bought High, 69 GEO. WASH. L. REV. 111, 127 (2000) ("'Circuit breakers' adopted in response to the 1987 market correction are designed to moderate systemic reckoning by imposing brief trading halts in declining markets.").
442. See Egon Guttman, Transfer of Securities: State and Federal Interaction, 12 CARDOZO L. REV. 437, 438 (1990) (explaining that the "paper crunch" of the 1960s led to broker-dealer bankruptcies and creation of the Securities Investor Protection Corporation).