SEC Sets Rules to Let Brokers Run Fee-Based Accounts (Update3)

Sept. 19 (Bloomberg) -- The U.S. Securities and Exchange Commission approved a plan to let brokerages sell shares to clients who hold fee-based accounts, pleasing investor advocates by subjecting firms to stiff consumer-protection requirements.

The SEC will require securities firms to give customers written notice before making so-called principal trades, or selling customers stock that brokerages hold in their own accounts. The rules, passed on a 4-0 vote in Washington today, will be temporary while the SEC reviews how well they work.

The SEC took action after a federal appeals court in Washington rejected regulations that allowed brokers to offer fee-based services without agreeing to act in the clients' best interest and provide full disclosure of potential conflicts. Investor groups were concerned that brokers would saddle clients with underperforming stocks.

Under the rules passed today, the SEC ``required more extensive disclosure than we anticipated,'' said Barbara Roper, director of investor protection at the Washington-based Consumer Federation of America. ``This should provide a significant heads up to investors that they are in a conflicted relationship.''

Investment advisers must provide written notice and get consent in advance of filling a customer order with securities from the firm's own portfolio. Under the court ruling, brokerages that provide fee-based accounts were considered investment advisers and would have had to follow these procedures.

The SEC rule, which expires at the end of 2009, will allow brokers who run fee-based accounts to meet the written notification requirements by providing a single disclosure statement on potential principal transactions. Oral notification would then be given by the broker prior to each actual transaction. Customers can revoke their consent.

$300 Billion

The March court decision had the potential of forcing brokerage firms to close accounts that oversee $300 billion in clients' money by Oct. 1. Such accounts charge customers an annual fee for buying and selling securities, rather than charging commissions on a per-trade basis.

The SEC rule ``delivers increased consumer choice within the constraints set by the court,'' Marc Lackritz, the president of the Securities Industry and Financial Markets Association, said in a statement. Sifma, whose members include Morgan Stanley and Merrill Lynch & Co., is Wall Street's biggest lobbying group.

Municipal Bonds

The new regulations, which take effect Sept. 30, prohibit brokers from making principal trades in fee-based accounts when the firm issues or underwrites the stock. Brokers will be allowed to sell clients municipal bonds they issue.

Investors were ``faced with two less than satisfactory options'' after the court decision, SEC Commissioner Kathleen Casey said. ``They can return to a likely more costly commission- based brokerage account'' or switch to an investment adviser, which would ``make it unfeasible for them to purchase municipal securities,'' she said.

Separately, the SEC approved rules today that would allow banks to sell securities, such as mutual funds and variable annuities, without having to register with the agency as brokers. The regulations must also be adopted by the Federal Reserve, which will consider them at a Sept. 24 meeting.

The Fed ``has worked hard with the SEC to develop rules that are workable and ensure that banks can continue to meet the needs of their customers,'' Federal Reserve Governor Randall Kroszner said in a statement. ``These rules will benefit customers and banks by maintaining healthy competition in financial services.''

To contact the reporter on this story: Jesse Westbrook in Washington at jwestbrook1@bloomberg.net; Miles Weiss in Washington at mweiss@bloomberg.net.

To contact the editor responsible for this story: Erik Schatzker at eschatzker@bloomberg.net