Compliance March 31, 2007

SEC “Merrill Lynch Rule″ Governing Advice Struck Down

The Securities and Exchange Commission’s (SEC) rule exempting certain broker-dealers who offer investment planning advice from strict disclosure requirements was overturned Friday.
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In its 2-1 ruling, in the case Financial Planning Association (FPA) vs. the Securities and Exchange Commission (SEC), the U.S. Court of Appeals for the District of Columbia Circuit said the SEC had overstepped its authority in issuing the 2005 rule.

The rule, referred to as “the Merrill Lynch rule,’ exempts broker-dealer firms that provide investment advice if the advice is “solely incidental to brokerage services provided on a customer’s account” and if specific disclosure is made to the customer, from regulation under the Investment Advisers Act of 1940. The exemption was issued to clear up regulatory confusion so that brokers could offer fee-based accounts without having to register as financial advisers, according to the Securities Industry and Financial Markets Association (SIFMA).

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The Financial Planning Association (FPA), which represents accountants, bankers, attorneys, insurance agents and others who offer financial planning services, brought the suit arguing the SEC should not have adopted regulations which exempted certain broker-dealers from registering as advisers and allowed stock brokers to give advice to clients without having to disclose conflicts of interest, according to Reuters.

The court ruled that the SEC’s rule is inconsistent with the Act because, among the six exemptions from the definition of “investment adviser” provided for by the Act, is one that exempts any broker or dealer “whose performance of such services is solely incidental to the conduct of his business as a broker or dealer” and “who receives no special compensation therefor.” The Act also gave the SEC the power to exempt other persons not within the intent of the law’s other exemptions. Therefore, the court said that charging asset-based fees means they must register as advisers.

“Now that the SEC rules have been overturned, some regulatory uncertainty will exist until new rules are promulgated,’ SIFMA predicted, in a statement released Friday afternoon.

“In the wake of this decision, our highest priority must be to our investors – ensuring there is no disruption to our customers while we wait for the SEC to provide interim guidance which conforms to the court’s ruling,’ said Ira Hammerman, general counsel at SIFMA, in the statement; “In the meantime, we encourage firms affected by today’s verdict to comply with the decision while simultaneously working to provide customers as much disclosure as is reasonable, given the ruling.’

Compliance March 30, 2007

U-5 Notices Get Absolute Privilege

The New York Court of Appeals ruled that the notices employers must provide to the National Association of Securities Dealers (NASD) when they terminate an employee cannot be used as grounds for a lawsuit.
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The court said, in the 4-2 opinion in the case Rosenberg v. MetLife written by Judge Victoria Graffeo, that the U-5 notices detailing the reasons for termination – which are available to regulators and potential employers – have absolute privilege, rather than qualified privilege, because they can be the first step in formal disciplinary charges in NASD’s quasi-judicial process of punishing securities dealers.

According to the New York Law Journal, an absolute privilege protects a securities firm from liability for a defamation claim regardless of motive, whereas a qualified privilege is more limited and may be vitiated upon a showing of actual malice, which may include recklessness or negligence

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“The form is designed to alert the NASD to potential misconduct and, in turn, enable the NASD to investigate, sanction and deter misconduct by its registered representatives,’ Graffeo wrote. She went on to say that the U-5 forms pose a threat to the public, which “faces the potential for substantial harm if exposed to unethical brokers.’

Former MetLife Inc. employee Chaskie Rosenberg, along with others in the firm’s All-Boro agency, were involved in efforts to market products to members of the Hasidic population in Brooklyn, New York. MetLife closed that agency in 2000 after two audits revealed it was accepting checks from third-parties for the payment of life insurance premiums, which can mean that brokers are involved in the “speculative insurance’ or money laundering.

Rosenberg was reassigned after the All-Boro agency was closed, but was later terminated after another audit found he had “appeared to have violated company policies and procedures involving speculative insurance sales and possible accessory to money-laundering violations.”

Following his termination, Rosenberg sued MetLife over claims of misrepresentation and libel, but Southern District of New York Judge Jed Rakoff dismissed his claim, at which point Rosenberg brought his case to the appeals court.

The appeals court deemed the U-5 notices as having absolute privilege, but Judge Eugene Pigott Jr. filed a dissenting opinion and disputed the fact that U-5 notices can be used as the “first step’ in a quasi-judicial proceeding against a securities industry employee.

“Because the Form U-5 is not a part of any judicial process, and given the serious potential damage to an employee’s reputation and business prospects, any communication associated with the Form is amply protected by a qualified rather than an absolute privilege,” Pigott wrote.

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