The U.S. Court of Appeals for the Tenth Circuit (the “Appeals Court”) affirmed a district court decision granting summary judgment to 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”) in connection with the sale of a variable universal life insurance policy. (The district court decision was discussed in the September 15, 2009 Alert.) 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’.
Broker-Dealer Exclusion. The Appeals Court’s analysis focused on the whether the investment advisory services provided by the sales representative fell within the broker‑dealer exclusion in Section 202(a)(11)(C) of the Advisers 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. The Appeals Court found that the exclusion applies to “a broker-dealer who provides advice that is attendant to, or given in connection with, the broker-dealer’s conduct as a broker or dealer, so long as he does not receive compensation that is (1) received specifically in exchange for the investment advice, as opposed to for the sale of the product, and (2) distinct from a commission or analogous transaction-based form of compensation for the sale of a product. The quantum or importance of the broker-dealer’s advice is relevant only insofar as the advice cannot supersede the sale of the product as the ‘primary’ goal of the transaction or the ‘primary’ business of the broker-dealer.”
Evidentiary Record. The Appeals Court held that the record established that (a) advice was given by the sales representative only in connection with the selling the variable insurance product to the plaintiffs, which was the primary object of the transaction, (b) the compensation paid the sales representative relating to the transaction was for selling the variable insurance product, not for providing investment advice; and (c) the $500 “Production Credit” paid to the sales representative for the sale of the variable insurance product was a traditional, transaction-based commission and thus was not “special compensation.” Responding to plaintiffs’ argument that an issue of fact sufficient to defeat a motion for summary judgment existed because of the possibility of a link between the advice given by the sales representative and the compensation received, the Appeals Court pointed to the following undisputed facts: (A) the sales representative received compensation only after selling the variable insurance product; (B) the sales representative would have been fired if he did not meet sales goals; and (C) the sales representative gave advice on other occasions without receiving compensation. The Appeals Court found that these facts compelled the conclusion that the sales representative was compensated for selling the variable insurance product, not specifically for rendering advice, and there was no basis for a reasonable jury to conclude otherwise.
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 where their activities may overlap and in the context of servicing retail customers. 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 both the Appeals Court’s and district court’s decisions, 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. This effort has resulted in a RAND Corporation report on investor and industry perspectives on investment advisers and broker‑dealers (as discussed in the January 8, 2008 Alert). More recently, in response to a mandate in the Dodd-Frank Act, the SEC has delivered a study to Congress recommending that broker‑dealers and investment advisers be subject to a uniform fiduciary standard of conduct in providing personalized investment advice about securities to retail investors, and that the standard be no less stringent than that currently applied to investment advisers (as discussed in the January 25, 2011 Alert).