SEC's 'Solely Incidental' Broker-Dealer Exclusion: A Breakdown

According to the SEC, “when a broker-dealer exercises investment discretion, it is not providing advice to customers that is in connection with and reasonably related to effecting securities transactions; rather, the broker-dealer is making investment decisions relating to the purchase or sale of securities on behalf of customers on an ongoing basis.” Thus, a broker-dealer’s exercise of unlimited discretion would not be solely incidental to the broker-dealer’s business, and the exclusion would not apply under such circumstances.

The SEC has also previously determined that a broker-dealer’s exercise of limited discretionary authority could be considered a service that is solely incidental to the brokerage business. Therefore, a broker-dealer’s exercise of temporary or limited discretion may indicate that a specific relationship is not “primarily advisory in nature.”

The SEC identified examples in the interpretation that it considers to demonstrate a broker-dealer’s temporary or limited discretion. Those examples include transactions to:

• Purchase or sell a security or type of security when a customer is unavailable for a limited period of time, if the purchase or sale occurs on an isolated or infrequent basis.
• Purchase or sell securities to satisfy margin requirements or other customer obligations that the customer has specified.
• Sell specific bonds or other securities and purchase similar bonds or other securities in order to permit a customer to realize a tax loss on the original position.

Nevertheless, the interpretation reminds broker-dealers that “the totality of the facts and circumstances would be relevant to determining whether temporary or limited discretion is consistent with the solely incidental prong.”

Monitoring Accounts

During the rulemaking process, the SEC received various comments about the applicability of the exclusion when broker-dealers monitor the status and performance of a customer’s account. The SEC disagreed with some commenters’ position that any monitoring of customer accounts is inconsistent with the exclusion. Thus, the interpretation confirms that a broker-dealer’s review of accounts does not automatically fall outside of the exclusion.  However, the SEC declined to establish a threshold about the situations in which monitoring is solely incidental to a broker-dealer’s business.

The interpretation encourages broker-dealers to implement policies and procedures that will help demonstrate whether any monitoring is related to the primary business of effecting transactions. Such policies and procedures may include information such as: whether a registered representative may agree to monitor a customer’s account at specific time frames for the purpose of determining whether to provide a buy, sell or hold recommendation to a customer; and, for dually registered firms, the level and type of monitoring the firm provides in advisory and brokerage accounts.

Because the SEC believes that the interpretation generally confirms the existing scope of the exclusion, it became effective upon publication in the Federal Register on July 12, 2019. As applicable, the SEC will consider further comments on the interpretation and evaluate whether additional guidance is appropriate in the future.

— Related on ThinkAdvisor:

• SEC’s Regulation Best Interest: A Breakdown
• The SEC Investment Adviser Standard of Conduct: A Breakdown
• SEC’s New Form CRS: A Breakdown

Beth Miller is an attorney with Spencer Fane LLP in the firm’s Overland Park, Kansas, office. Her practice focuses on helping clients by identifying practical solutions to a wide variety of legal matters in the areas of employer-sponsored retirement plans, executive compensation, fiduciary obligations and advisory services. She can be reached at [email protected].