SEC Merrill Lynch Rule Struck Down by the US Court of Appeals

SEC’s “Merrill Lynch Rule” Struck Down by the US Court of Appeals

In a 2 to 1 decision this morning, the US Court of Appeals struck down the US Securities and Exchange Commission’s rule on fee based broker accounts, which as become commonly known as the “Merrill Lynch Rule.” This rule was first proposed in late 1999 and formally adopted in 2005. This rule allowed stockbrokers to act as “advisors” and to charge percent of assets fees. Prior to this rule, only investment advisors who registered with the SEC or with the states and who were regulated under the Investment Advisers Act of 1940 were permitted to do this. Under the Merrill Lynch Rule, brokers could call themselves advisers, yet remain exempt from regulation under the Investment Advisers Act, as amended.

US Appeals Court Judges Judith Rogers and Brett Kavanaugh decided that the SEC had exceeded its authority in granting this exemption to stockbrokers. The ruling found no congressional intent to “support the SEC’s interpretation of its authority.” Whether the SEC will appeal this decision to the US Supreme Court is not clear at this point. As the decision stands today, brokerage firms would need either to convert their client wrap accounts, which currently hold several hundred billions of dollars in client assets, or be regulated by the Investment Advisers Act. Judge Merrick Garland dissented.

The Skilled Investor has written previous articles about this exemption and about the regulation of brokers and investment advisers. (See this article on the securities industry’s financial incentives, which includes an earlier discussion of the Merrill Lynch Rule: The securities industry calls marketing and selling: “advising”). You may also wish to peruse our extensive collection of articles about financial advisors in these categories: Selecting an Advisor, Regulation of Advisors, Payment of Advisors, and Advisor Fraud.)

This US Appeals court decision is an important legal victory for individual investors. Numerous surveys of investors have shown that they do not understand the important legal distinctions between securities brokers and investment advisors. For almost six and one-half years, since November 4, 1999 when the SEC proposed Rule 202(a)(11)–1.7 to regulate ‘‘fee based” and “discount” brokerage products offered by full-service broker-dealers, the SEC has just added to this ambiguity.

The Merrill Lynch Rule allowed stockbrokers to call themselves “advisors,” “counselors,” and other similar terms that implied they were helping clients to make financial and investment decisions in their clients’ best interests. In fact, brokers have had no legal obligation to act in the best interests of their clients. Instead, securities laws only required them to sell “suitable” financial and investment products to the public. The definition of a “suitable” investment is vague at best. The full-service brokerage industry wanted the ability to market themselves as advisors without the legal obligations that the Investment Advisor’s Act entailed, and the SEC aided this effort for years.

These legal proceedings were prompted when the SEC formally adopted its “Merrill Lynch Rule” in 2005. The SEC then was sued by the Financial Planning Association and by the Consumer Federation of America. This link will take you to a press statement from the FPA about this court decision.

Related Personal Financial Planning Posts

• The Optimal Investment Strategy for Individual Investors ( The Solution - ONLY follow financial strategies that are scientific, passive, diversified, savings focused, risk controlled, low cost, and tax efficient A previous article, "The Problem - Straight answers about personal financial and investment planning are difficult to find," summarized important reasons why individuals may experience difficulties, even if they are intent upon doing better with [...])
• The Quality and Cost of Advice Paid by Investment Sales Loads ( Can you really get free and objective investment advice, when you pay investment sales loads? Excessive investment expenses are one of the most significant barriers to your family's lifelong financial security. Excessive investment costs are a plague on your personal financial planning. While financial services industry sales people tell you that you need to pay more to [...])
• Use Caution with Classical Investment Books ( Use Caution with Classical Investment Books - A Tip from The Skilled Investor Individual investors should exercise caution when applying the tactics of classical investment books to current markets. The more handcrafted, seat-of-the-pants, and individual actor approach to the securities markets in the pre-computer, pre-networking era has given way to different practices. What might have worked [...])
• Commodity Futures in Your Investment Portfolio ( Commodity futures in your investment portfolio - Is there really any future for individual investors? The Skilled Investor's previous article, "Be wary of the new investment asset classes," voiced skepticism about many supposedly new asset classes. This article delves into the financial science behind this skepticism, as it relates to one of these supposedly new asset [...])
• Diversify fully within asset classes - Step 4 of 10 Financial Planning Steps in the Right Direction (CLICK HERE TO READ THE SKILLED INVESTOR's OTHER ARTICLES ABOUT THESE "10 FINANCIAL PLANNING STEPS IN THE RIGHT DIRECTION." Diversification is genuinely an investment “free lunch,” and it is a key contributor to improved investment risk management. Diversification has become an axiom of personal investing, because the specific risks of businesses and other investment entities can be [...])
• Understand the Confusing Securities Market Motion Picture ( Securities markets are usually very quick to adjust prices to reflect new information. However, this price adjustment process may take longer and be more volatile, if the new information is ambiguous. At any point in time, market participants will already have used more or less rigorous valuation methods to judge their expected risk-adjusted value of securities. [...])
• The Cost of Investment Counselors When You Pay Investment Sales Loads ( How expensive is financial advisor compensation paid via sales loads? A sales load might be the method that you prefer to compensate your broker or advisor. If your advisor is truly competent and ethical, he may be able to manage properly the inherent conflicts of interest that are associated with commissioned investment product sales. Even if [...])
• No Financial Planning Software or Calculator Can Predict the Future ( No financial planning software and no investment growth calculator can predict the future The future is simply not predictable, even with automated financial planning software. A previous financial article, “The Solution - ONLY follow financial strategies that are scientific, passive, diversified, savings focused, risk controlled, low cost, and tax efficient,” suggested that investors are much better off [...])