19 April 2018 SEC votes 4-1 to propose new rules addressing conflicts of interest among investment brokers Package of initiatives would require brokers to disclose and mitigate conflicts; Stein derides proposals as 'regulation status quo' The Securities and Exchange Commission on April 18, 2018, voted 4-1 to issue for public comment a package of rules that would overhaul the Commission's conflict-of-interest rules for broker-dealers, require new disclosures and restrict how brokers and investment advisers use certain titles. Democratic Commissioner Kara Stein voted against the package, calling it a "squandered opportunity," while Democratic Commissioner Robert Jackson and Republicans Michael Piwowar and Hester Peirce voted with Chairman Jay Clayton to propose the rules while expressing concerns, saying they wanted to see what public comments would be prompted by the proposals. The proposals, more than 1,000 pages long, are widely seen as the SEC's effort to step into — and perhaps resolve — the debate over how brokers should interact with their clients, which has roiled the financial industry and its regulators since the Obama Administration's Department of Labor promulgated a fiduciary rule affecting all advisers to retirement plans in 2016. The Trump Administration's Labor Department has delayed implementing portions of that regulation, and in March a three-judge panel of the Fifth Circuit Court of Appeals handed down a 2-1 ruling vacating the DOL fiduciary rule in its entirety after a lawsuit by industry groups. Notably, while section 913 of the 2010 Dodd-Frank Act gave the SEC authority to establish a single, "unified" fiduciary standard of care for both brokers and advisers, the Commission's proposals did not use that construct; instead, the rules would largely continue to apply separate rules to the two groups. Attached with this alert please find PDFs with the text of the three rule proposals; 4-page statement from Chairman Clayton explaining their objectives, background and approach; and short SEC summaries of the package and the Regulation Best Interest proposal, as well as statements by the commissioners. Other materials related to the meeting are posted here and here. In his opening statement, SEC Chairman Jay Clayton said, "The framework of our proposal is straightforward. It reflects a multi-pronged effort to fill the gaps between investor expectations and legal requirements, thereby increasing investor protection and the quality of advice, while preserving investor access and investor choice, recognizing that access and choice are driven by what is available and how much it costs." In explanatory materials released by the SEC, Clayton said the first proposal, Regulation Best Interest, would require broker-dealers, when they recommend investment transactions to retail investors, "to act in the best interest of that customer at the time the recommendation is made, without placing the financial or other interest of the [broker] ahead of the interest of the retail customer. This best interest duty is discharged if the [broker] complies with a disclosure obligation, a care obligation, and two conflict-of-interest obligations." Other elements in the package would establish rules for when financial professionals can present themselves as "advisers" or "advisors," considered a chief source of confusion among retail investors; propose a "client relationship summary" (Form CRS) that would disclose material conflicts; and propose interpretive guidance designed to clarify the responsibilities of registered investment advisers under the existing standard of conduct. In her prepared statement, Dalia Blass, director of the SEC's Investment Management Division, said, "Regulation Best Interest will explicitly require for the first time in a commission rule that broker-dealers must act in their retail customers' best interest" and take "affirmative steps to address the material conflicts of interest that could create incentives to favor their own interest." The proposal would require that brokers disclose "key facts" about any potential conflicts, such as bonuses or fees for selling specific products, and would have to mitigate those conflicts or eliminate them. Brokers would also have to have a "reasonable basis" to believe investments they recommend are in a customer's best interest. While Clayton said the proposed best-interest standard for brokers would be a stronger rule than the "suitability" standard under which they now operate, it is less stringent than the current fiduciary standard for investment advisers, which requires them to place customers' interests above their own, or the standard mandated by the 2016 DOL rule. Those rules create a basis for investors to sue if the standard is violated, but under Wednesday's proposals, disputes would still be settled in FINRA arbitration hearings. In a nearly half-hour dissenting statement from the dais, Commissioner Stein said, "Despite the hype, today's proposal fails to provide comprehensive reform or adequately enhance existing rules … Perhaps it would have been more accurate to call it 'Regulation Status Quo.' " Stein said the proposed best interest rule for brokers "merely reaffirms that broker-dealers have to meet their suitability obligations" and "mandates a few disclosures … Most of this is already required by FINRA or federal securities laws. It's hard to fathom why we are being asked to vote on this particular proposal today." She said that despite the length of the Regulation Best Interest proposal, it contains no definition of the term "best interest" and effectively "protects the broker, not the customer … . Does it require financial professionals to put their customer's interest first and fully disclose any conflicts? No. Does it require broker-dealers to become fiduciaries? No. Does it require financial professionals to provide retail customers with the best available options? No." Stein added that the proposals "would make it difficult for the Commission to offer materially better rules." Commissioner Jackson called the best-interest regulation "far too ambiguous" and faulted the Commission for not simply using the standard authorized by Dodd-Frank. While Jackson expressed support for the DOL's rulemaking and criticized the Fifth Circuit Court's ruling overturning it, he said it was too important, given the court's action, that the SEC move forward. He added that he was concerned the proposal "actually strengthens the [current] suitability standard." Jackson said that while requiring brokers to mitigate conflicts was "an important step forward, we cannot expect them to end the most egregious practices," such as contests and bonuses. Commissioner Peirce said she did not agree with Stein that "the emperor has no clothes," prompting laughter when she said that under the new standard, "the emperor will wear more clothes — perhaps a sweater." Peirce said the SEC should not try to use the same form of economic analysis the DOL had used in drafting its 2016 proposal: "It's wonderful to quantify things when you can, but it gives a false sense of security … A lot of assumption were packed into" the DOL's data, and "we should not repeat those errors." Peirce said Regulation Best Interest was mislabeled: "It would be better to say we're proposing a suitability-plus standard." She said the proposals risked exacerbating a long-term trend of decreasing numbers of registered broker-dealers, but altogether they represented an "excellent start on the path toward reform." Commissioner Piwowar said, "The size of this package alone gives me pause. If it takes us that many pages to explain what we are trying to do, dare I say that our solution might necessarily lack the clarity that is needed to address retail investors' confusion?" But he said the Regulation Best Interest proposal "is a solid building block … No longer can anyone say the SEC really needs to do something about this." The SEC will accept public comments on the proposals for 90 days before revising them and setting a vote to finalize the rules.
Document ID: 2018-0847 | |||||
