Thursday, April 19, 2018

The SEC's Fiduciary Rulemaking

Yesterday, the SEC announced three different proposals related to financial advice for retail customers.  The SEC's press release summarized the proposals:

Under proposed Regulation Best Interest, a broker-dealer would be required to act in the best interest of a retail customer when making a recommendation of any securities transaction or investment strategy involving securities to a retail customer.  Regulation Best Interest is designed to make it clear that a broker-dealer may not put its financial interests ahead of the interests of a retail customer in making recommendations.

In addition to the proposed enhancements to the standard of conduct for broker-dealers in Regulation Best Interest, the Commission proposed an interpretation to reaffirm and, in some cases, clarify the Commission’s views of the fiduciary duty that investment advisers owe to their clients.  By highlighting principles relevant to the fiduciary duty, investment advisers and their clients would have greater clarity about advisers’ legal obligations.

Next, the Commission proposed to help address investor confusion about the nature of their relationships with investment professionals through a new short-form disclosure document — a customer or client relationship summary.  Form CRS would provide retail investors with simple, easy-to-understand information about the nature of their relationship with their investment professional, and would supplement other more detailed disclosures.  For advisers, additional information can be found in Form ADV.  For broker-dealers, disclosures of the material facts relating to the scope and terms of the relationship would be required under Regulation Best Interest.

Finally, the Commission proposed to restrict certain broker-dealers and their financial professionals from using the terms “adviser” or “advisor” as part of their name or title with retail investors.  Investment advisers and broker-dealers would also need to disclose their registration status with the Commission in certain retail investor communications.

With the comment window now open, interested stakeholders have 90 days to provide the SEC with comments on the proposals.

In the open session announcing the proposals, the sitting SEC commissioners expressed significant reservations about many of the proposals.  Commissioner Stein voted against releasing the proposals for a variety of reasons, including a concern that proposed Regulation Best Interest wouldn't actually require brokerages to act in the best interests of retail customers:

In addition, as I mentioned previously, because there is no definition of the best interest standard in the proposal, the name of the rule, in and of itself, is confusing. Calling the proposal Regulation Best Interest could cause retail investors to reasonably believe that broker-dealers are required to act in their clients’ best interests. Perhaps it would be more accurate to call this proposal “Regulation Status Quo.” Calling it Regulation Best Interest is not just confusing, it is in effect a form of mislabeling, which may be misleading and which could have deleterious consequences.  Indeed, one of the recommendations we are considering today is a proposal to restrict the use of the terms “advisor” and “adviser” by a broker-dealer unless it is also registered as an investment adviser. We should be logically consistent ourselves.

Collectively, the proposals span over a thousand pages.  It'll take some time to dig through and digest this.  If any stakeholders see more elegant ways of addressing the problem, there may some support on the commission for changes designed to make the proposals shorter.  Commissioner Piwowar noted his concern with the sheer volume of the package: 

Nevertheless, I cannot hide my misgivings about certain aspects of the nearly 1,000 page tome before us today. 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? With that overarching concern off my chest, I will now discuss my views on each of the three proposals in turn.

My sense, after watching the announcement yesterday, is that these proposals remain malleable.  Most of the commissioners seemed to have reservations about different aspects of the proposals.  Hopefully the process results in a series of rules that significantly improve outcomes for retail investors.

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Just from an initial scan of the proposals, I am most concerned with the naming of the "best interests" standard. There is ample legal precedent that the term "best interests" refers to the fiduciary duty of loyalty. Yet, under the SEC's proposed rule, it is unclear whether fiduciary duties are to be applied to brokers.

I would hope that others in the legal community pay attention to this, and help analyze the proposals. It would be a shame if the term "best interests" is hijacked and, in the process, weakens the fiduciary standard of conduct.

Posted by: Ron Rhoades | Apr 19, 2018 11:50:19 AM

I share the concern. Much of the guidance for the current suitability rule requires advice to be "consistent with a client's best interest." I'm not sure what the difference is between "in the best interest" and the existing "consistent with" language.

Posted by: Ben Edwards | Apr 19, 2018 11:53:30 AM

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