Financial Planning Ass'n v. S.E.C.

Decision Date30 March 2007
Docket NumberNo. 04-1242.,04-1242.
Citation482 F.3d 481
PartiesFINANCIAL PLANNING ASSOCIATION, Petitioner v. SECURITIES AND EXCHANGE COMMISSION, Respondent.
CourtU.S. Court of Appeals — District of Columbia Circuit

Merril Hirsh argued the cause for petitioner. With him on the briefs was Jonathan A. Cohen.

Rachel M. Weintraub and Mercer E. Bullard were on the brief for amici curiae Consumer Federal of America and Fund Democracy, Inc. in support of petitioner.

Debra G. Speyer was on the brief for amicus curiae Public Investors Arbitration Bar Association in support of petitioner.

Rex A. Staples was on the brief for amicus curiae North American Securities Administrators Association, Inc. in support of petitioner.

Rada L. Potts, Senior Litigation Counsel, Securities & Exchange Commission, argued the cause for respondent. With her on the brief were Brian G. Cartwright, General Counsel, Jacob H. Stillman, Solicitor, Michael A. Conley, Special Counsel, and Jeffrey T. Tao, Senior Counsel.

Before: ROGERS, GARLAND and KAVANAUGH, Circuit Judges.

Opinion for the Court filed by Circuit Judge ROGERS.

Dissenting opinion filed by Circuit Judge GARLAND.

ROGERS, Circuit Judge.

Brokers and dealers are not subject to the requirements of the Investment Advisers Act ("IAA") where their investment advice is (1) "solely incidental to the conduct of [their] business as a broker or dealer," and (2) the broker or dealer "receives no special compensation therefor." 15 U.S.C. § 80b-2(a)(11)(C) (2000). The Securities and Exchange Commission, acting pursuant to § 202(a)(11)(F) and § 211(a) of the IAA, 15 U.S.C. §§ 80b-2(a)(11)(F)1, 80b-11(a), promulgated a final rule exempting broker-dealers2 from the IAA when they receive "special compensation therefor." See "Certain Broker-Dealers Deemed Not to be Investment Advisers," 70 Fed.Reg. 20,424 (Apr. 19, 2005). The Financial Planning Association ("FPA") petitions for review of the final rule on the ground that the SEC has exceeded its authority. We agree, and we therefore grant the petition and vacate the final rule.

I.

The IAA was enacted by Congress as one title of a bill "to provide for the registration and regulation of investment companies and investment advisers." Pub.L. No. 76-768, tit. II, 54 Stat. 847 (1940). The other title was the Investment Company Act ("ICA"). Pub.L. No. 76-768, tit. I, 54 Stat. 789 (1940). These were the last in a series of congressional enactments designed to eliminate certain abuses in the securities industry that contributed to the stock market crash of 1929 and the depression of the 1930s. Congress had previously enacted the Securities Act of 1933, the Securities Exchange Act of 1934 (hereinafter "the Exchange Act"), the Public Utility Holding Company Act of 1935, and the Trust Indenture Act of 1939.

"A fundamental purpose, common to these statutes, was to substitute a philosophy of full disclosure for the philosophy of caveat emptor and thus to achieve a high standard of business ethics in the securities industry." SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 186, 84 S.Ct. 275, 11 L.Ed.2d 237 (1963). The IAA arose from a consensus between industry and the SEC "that investment advisers could not `completely perform their basic function—furnishing to clients on a personal basis competent, unbiased, and continuous advice regarding the sound management of their investments—unless all conflicts of interest between the investment counsel and the client were removed.'" Id. at 187, 84 S.Ct. 275 (citation omitted). According to the Committee Reports, "[t]he essential purpose of [the IAA] ... [was] to protect the public from the frauds and misrepresentations of unscrupulous tipsters and touts and to safeguard the honest investment adviser against the stigma of the activities of these individuals by making fraudulent practices by investment advisers unlawful." H.R.Rep. No. 76-2639, at 28 (1940).

"Virtually no limitations or restrictions exist with respect to the honesty and integrity of individuals who may solicit funds to be controlled, managed, and supervised .... Individuals assuming to act as investment advisers at present can enter profit-sharing contracts which are nothing more than `heads I win, tails you lose' arrangements. Contracts with investment advisers which are of a personal nature may be assigned and the control of funds of investors may be transferred to others without the knowledge or consent of the client."

S.Rep. No. 76-1775, at 21-22 (1940).

Under the IAA, investment advisers are required, among other things, to register and to maintain records, 15 U.S.C. § 80b-3(c) & (e); to limit the type of contracts they enter, id. § 80b-5; and not to engage in certain types of deceptive and fraudulent transactions, id. § 80b-6. Congress has amended the IAA on several occasions,3 see VII Louis Loss & Joel Seligman, Securities Regulation 3314-15 (3d ed.2003), but the provisions at issue in this appeal have remained, in relevant part, unchanged.

In § 202(a)(11) of the IAA, Congress broadly defined "investment adviser" as

"any 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 and as part of a regular business, issues or promulgates analyses or reports concerning securities ...."

15 U.S.C. § 80b-2(a)(11). Carving out six exemptions from this broad definition, Congress determined that an "investment adviser" did not include:

(A) a bank, or any bank holding company as defined in the Bank Holding Company Act of 1956 which is not an investment company, except that the term "investment adviser" includes any bank or bank holding company to the extent that such bank or bank holding company serves or acts as an investment adviser to a registered investment company, but if, in the case of a bank, such services or actions are performed through a separately identifiable department or division, the department or division, and not the bank itself, shall be deemed to be the investment adviser;

(B) any lawyer, accountant, engineer, or teacher whose performance of such services is solely incidental to the practice of his profession;

(C) any broker or dealer [1] whose performance of such services is solely incidental to the conduct of his business as a broker or dealer and [2] who receives no special compensation therefor;

(D) the publisher of any bona fide newspaper, news magazine or business or financial publication of general and regular circulation;

(E) any person whose advice, analyses, or reports relate to no securities other than securities which are direct obligations of or obligations guaranteed as to principal or interest by the United States, or securities issued or guaranteed by corporations in which the United States has a direct or indirect interest which shall have been designated by the Secretary of the Treasury, pursuant to section 3(a)(12) of the Securities Exchange Act of 1934, as exempted securities for the purposes of that Act; or

(F) such other persons not within the intent of this paragraph, as the Commission may designate by rules and regulations or order.

15 U.S.C. § 80b-2(a)(11) (emphasis added). Subsections (C) and (F) are at issue in this appeal.

Before enactment of the IAA, broker-dealers and others who offered investment advice received two general forms of compensation. Some charged only traditional commissions (earning a certain amount for each securities transaction completed). Others charged a separate advice fee (often a certain percentage of the customer's assets under advisement or supervision). See 11 Fed.Reg. 10,996 (Sept. 27, 1946). The Committee Reports recognized that the statutory exemption for broker-dealers reflected this distinction; the Reports explained that the term "investment adviser" was "so defined as specifically to exclude ... brokers (insofar as their advice is merely incidental to brokerage transactions for which they receive only brokerage commissions)." S.Rep. No. 76-1775, at 22 [HA 164]; H.R.Rep. No. 76-2639, at 28 [HA 168].

The final rule took a different approach. After determining in 1999 that certain new forms of fee-contracting adopted by broker-dealers were "not ... fundamentally different from traditional brokerage programs," the SEC proposed a rule very similar to the final rule, see Notice of Proposed Rulemaking, 64 Fed.Reg. 61,228 (Nov. 10, 1999) ("1999 NOPR"), stating it would act as if it had already issued the rule, id. at 61,227. In adopting the temporary rule, pursuant to subsection (F) and its general rulemaking authority under IAA § 211(a), the SEC exempted a new group of broker-dealers from the IAA. 64 Fed.Reg. 61,226 (Nov. 10, 1999). After reproposing the rule in January 2005, again pursuant to its authority under subsection (F) and § 211(a), the SEC adopted a slightly modified final rule on April 12, 2005, codified at 17 C.F.R. § 275.202(a)(11)-1. 70 Fed.Reg. 20,424, 453-54.

The final rule provides, generally, in Paragraph (a)(1), on "fee-based programs," that a broker-dealer who (1) receives special compensation will not be deemed an investment adviser if (2) any advice provided is solely incidental to brokerage services provided on a customer's account and (3) specific disclosure is made to the customer.4 In Paragraph (a)(2), on discount brokerage programs, a broker-dealer will not be deemed to have received special compensation merely because it charges one customer more or less for brokerage services than it charges another customer. Paragraph (b) lists three non-exclusive circumstances in which advisory services, for which special compensation is received under paragraph (a)(1), would not be performed "solely incidental to" brokerage: when (1) a...

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