On August 31, 2009, the United States District Court for the Western District of Oklahoma (the “District Court”) granted a motion for summary judgment by an insurance company and its affiliated broker-dealer (collectively referred to as the “company”) that were being sued for alleged violations of the Investment Advisers Act of 1940 (the “Advisers Act” or “Act”) in connection with the sale of a variable universal life insurance policy. The plaintiffs alleged that a sales representative of the company had acted as an investment adviser in recommending that the plaintiffs purchase the policy, and thus the company was subject to the Advisers Act. The plaintiffs further alleged that the company had violated the fiduciary duty it owed to the plaintiffs under the Advisers Act by failing to disclose the conflicts of interest created by the commission structures, fees and other policies that gave the sales representative an incentive to put his own financial interest ahead of the plaintiffs’.
In granting the company’s motion for summary judgment, the District Court examined whether the investment advisory services provided by the sales representative fell within the broker-dealer exclusion in Section 202(a)(11)(C) of the Act, which provides that that “any broker or dealer whose performance of [advisory] services is solely incidental to the conduct of its business as a broker or dealer and who receives no special compensation therefor” is not an investment adviser for purposes of the Act. (Although the District Court and this article refer to the insurance company and its affiliated broker‑dealer collectively, the opinion’s clear focus is on the issue of whether the broker‑dealer, not the insurance company, could rely on the broker-dealer exclusion.) The District Court found that there was no genuine issue of material fact to be litigated because the evidence presented, even when viewed in the light most favorable to the plaintiffs, indicated that each of the requirements of the broker-dealer exclusion had been satisfied – namely, (i) the sales representative was a broker of the company’s products; (ii) the sales representative’s provision of investment advisory services to the plaintiffs was solely incidental to the conduct of his and the company’s business as brokers of the company’s products; and (iii) no special compensation for providing advisory services was paid to the company or the sales representative.
Solely Incidental. In addressing the “solely incidental” requirement, the District Court analyzed the statutory language, the legislative history and past SEC interpretations to conclude that under this element of the broker-dealer exclusion advisory services must be solely attendant to or solely in connection with brokerage activities, and need not be only a minor or insignificant part of the conduct of the company’s brokerage business as the plaintiffs contended. The District Court noted the dearth of appellate guidance on the “solely incidental” element of the broker‑dealer exclusion, which it regarded as the most difficult element of the exclusion analytically.
Special Compensation. Regarding the receipt of special compensation, the District Court focused on the fact that (a) the plaintiffs were never presented with a separate charge for investment advisory services, (b) the only payments received by the insurance company with respect to the policy were the premiums paid by the plaintiffs and (c) the only compensation received by the sales representative with respect to the policy was a “Production Credit” paid related to the policy’s sale.The Broader Context. This decision comes against a backdrop of judicial, regulatory and legislative developments over the last several years addressing how broker-dealers and investment advisers should be regulated, particularly in areas where their activities may overlap. As discussed in the April 10, 2007 Alert, a decision of the United States Court of Appeals for the D.C. Circuit, which was cited in the District Court’s decision, vacated a 2005 SEC rule that created additional exceptions from the definition of “investment adviser” under the Advisers Act for certain fee‑based and discount brokerage programs. In conjunction with its adoption of the vacated rule, the SEC had also begun examining how it might improve its oversight and regulation of broker-dealers and investment advisers to better reflect current industry practices and investor perceptions. To date, this effort has resulted in a RAND Corporation report on investor and industry perspectives on investment advisers and broker‑dealers (see the January 8, 2008 Alert). More recently, the financial crisis has prompted legislative efforts to address the duty broker-dealers owe their customers. Following up on recommendations in the Treasury’s June 2009 white paper on financial regulatory reform (see the June 23, 2009 Alert), the Obama administration submitted to Congress proposed legislation designed to increase investor protections, which included a provision granting the SEC broad authority to promulgate rules requiring brokers, dealers and investment advisers providing investment advice to act solely in the interest of the customer or client without regard to any interest of the broker, dealer or investment adviser (see the August 4, 2009 Alert). Thomas v. Metropolitan Life Ins. Co., CIV-07-0121-F (WD Okla. Aug. 31, 2009).