BI > DECEMBER 2005

Brokers as Club Partners

Legal But Not Advisable

Q. I have been in an investment club partnership (affiliated with BetterInvesting) since 1992. I'm currently making a career change, moving from the IT field to a financial-planning position. Over the next few months I will be obtaining my securities licenses. In our partnership agreement it states, "None of the partners of this partnership shall be a broker." I would like to amend our agreement so that I can continue with the club. The other members are concerned that there may be a legal reason for the exclusion of brokers. Does anyone know whether this is the case? If it is legal, what are the possible concerns of having a broker as a member of an investment club?

A. There's no law against having a broker as an investment club member, but it often is in the best interest of the club not to allow it. This is because the broker's participation creates an additional burden for the club.

The National Association of Securities Dealers (NASD) regulates broker investment activities. You'll have to ask your brokerage firm's compliance department for specific requirements. But to comply with NASD regulations, a firm in general will:

• Limit the choice of investments the club can make.


• Ask you to submit every buy and sell decision the club makes to your management for approval.


• Limit the time frame in which the club can make a transaction.


• Require that the club account be held at the firm.

All these restrictions can limit the club's efficiency and profitability. Assuming you want to continue with your career change, you can withdraw from the club, the club can amend its partnership agreement or it can restructure into a traveling club. If your club agrees to amend the partnership to allow brokers as members, the burden is on you to comply with all regulations.

Your club could restructure itself as a traveling (portable) club. A traveling club is just like a traditional club, but with one major difference: Money isn't pooled to make investments. Therefore, the club isn't a business entity. No partnership agreement is needed, but the county clerk's office and IRS will both need to be notified that the club's partnership no longer exists.

The club operates like a traditional club in all other ways. A group of people still come together to present ideas for investment consideration, review the "portfolio" and participate in educational programs.

I don't recommend this option, however. Traveling clubs tend to have shorter life spans. Because no money is involved, club members tend to become lazy by missing meetings, coming late and being unprepared. The only exception to this rule seems to be when these clubs are in schools. Students tend to take the club more seriously, probably because their grades often depend on their participation in the club.

Your withdrawal from the club is probably the best option. You still might be able to participate in the club's activities even after withdrawing officially from the club. If your club allows visitors at its meetings, you could participate at its meeting but would forgo any further input in investment decisions. This type of club is a hybrid of a traditional and traveling club.

Inform the other members of the complications your being a broker could bring to the club. Present the possible solutions to your club. Then you can rest easy knowing you have done everything possible to do the right thing for your club.

Ask Colleen your club question by writing to colleen@ColleenMulder-Seward.com. Colleen holds an M.B.A. from Wayne State University. Since 2000 she has served on the board of directors for BetterInvesting's Southeastern Michigan Chapter. Colleen also writes the Retirement Intelligence Information Services newsletter for retirementcalc.com.