Lack of “Appeal” – Even less Appetizing


New York – Its official, the SEC has decided not to appeal the U.S. Court of Appeals for the District of Columbia Circuit’s decision to overturn the “Merrill Rule”. This leaves many fee-based brokers in the lurch and will force them to stop this method of payment altogether. Additionally, while the judgment has been focused on fee-based brokerage, there are potential consequences for sell-side and alternative research providers.

The History

In 1999, Merrill Lynch announced a new program called “Unlimited Advantage”. Under the program it would be charging fees based on assets under management for investment advice and unlimited trading. The move was, of course, in reaction to the thinning of commissions, but then SEC Chairman Arthur Levitt believed that Merrill Lynch was supporting his own view that a fee-based system removed the temptation for brokers to churn their accounts. As a result, Chairman Levitt supported Merrill’s move to asset-based fees by proposing that it be exempt from the Investment Advisors Act of 1940.

Impact on the Brokerage Industry

We previously expected that the Court’s decision would light a fire under the SEC to resolve this issue, but this has not been the case.  In fact, some in the brokerage industry have argued that the SEC’s decision not to appeal this ruling is a disservice to investors, because it will offer them less choice in how to pay for their brokerage services.  However, the decision can also be viewed as a more aggressive approach to upholding the Investment Advisers Act of 1940 and the fiduciary requirements associated with registrants under that Act.

The issue facing Bulge Bracket firms is that they will need to register as Registered Investment Advisers and undertake the associated fiduciary responsibilities.  In addition, many of these firms will have to deal with the issue of how they conduct their retail brokerage business at the same time as they are conducting principle trading or proprietary trading with their clients. Clearly, this is an implication that has occurred to the sell-side firms.

Of course, the issue of registering as an Investment Advisor also could impact sell-side firms’ research businesses if regulators were ever to come to the conclusion that providing research to clients was more than just “incidental” to their businesses.  This becomes a bigger issue in the future as unbundling makes it more transparent just how much buy-side clients are paying for sell-side research.  In fact, we know that this is one reason that many sell-side firms have argued against receiving checks from clients for their research.

Implications for Alternative Research

Another issue that arises – albeit not as a direct consequence – is the issue of where research lives on the advice scale and whether the treatment of such advice can be construed as “individualized” advice. We have been discussing this issue with several of our alternative research provider contacts. Some of the firms have taken steps to become registered investment advisers, while others continue to stand firmly behind the publisher’s exemption.

Of course, this raises the issue for buy-side users of alternative research that have choices about the research they use. If there are two research companies that have the same type of research service, and close to the same quality, then the one that has taken steps to become an IRA could get the nod over other due to the fiduciary requirements and regulatory oversight they must face.


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