SEC passes Regulation Best Interest, but fiduciary rules could make a comeback
Advisors and brokers will soon be faced with new SEC disclosure and compliance requirements, but the changes disappoint consumer advocates — and suggest more state regulatory action on fiduciary rules is likely.
The commissioners voted 3-1 on four items: Regulation Best Interest, Form CRS (a relationship summary form for clients), an interpretation of standards of conduct for RIAs, and an interpretation of the "solely incidental" clause for broker-dealers. The regulations take effect June 30, 2020.
From the moment it was introduced for public feedback, Reg BI was a controversial measure that received a warm reception by Wall Street firms and sharp criticism from consumer advocates for falling well short of what they deem to be necessary investor protections.
SEC Chairman Jay Clayton rebutted criticism during the hearing, saying Regulation Best Interest draws on “key fiduciary principles and cannot be satisfied through disclosure alone” — phrasing that was repeated by other SEC officials, though the commission’s meeting included lengthy discussion of new disclosure requirements.
The regulations, Clayton said, fulfill two objectives by bringing standards of conduct in line with reasonable investor expectations and preserving investor access to products and services.
“Regulation Best Interest will substantially enhance the broker-dealer standard of conduct,” Clayton said.
Commissioner Robert Jackson dissented, calling the proposal a "weak mix of measures" that did not even define the term best interest.
"Regulation Best Interest lowers the bar we set in last year’s proposal," Jackson said, arguing that the SEC should have taken advantage of regulatory authority to craft a fiduciary rule granted it by Congress in the 2010 Dodd-Frank Act.
Form CRS also came under lengthy discussion, with Commissioner Hester Peirce, quizzing SEC staff on how firms can satisfy its requirements (they will be permitted some leeway to use online tools).
John Taft, vice chairman at Baird, a regional broker-dealer says the regulation is a welcome addition because, in part, it doesn’t prioritize one business model over another.
“The beauty of Reg BI is that it doesn’t have to be just one,” Taft says, adding that it’s “huge” that the rule’s passage will result in a “substantively harmonized regulatory approach.”
The vote, however, left fiduciary advocates disappointed and may spur more state regulators to move forward with their own fiduciary rule proposals, resulting in a regulatory patchwork with some brokers held to a fiduciary standard and others not.
“My overall sense is that there is this promise of clarity, but in reality we are going to get a bunch of chaos,” says John Luksanski, a partner at law firm Reed Smith.
States’ regulators promulgating their own, stronger standards of conduct rules will likely find allies among Regulation Best Interest’s discontents.
“We oppose Reg BI because it doesn’t even do what it claims to do, which is require brokers to act in their customers’ best interest, at least not as any reasonable investor understands that term, or prevent them from putting their own interests first,” Barbara Roper, Director of Investor Protection, Consumer Federation of America, tweeted days prior to the vote.
Nevada and New Jersey have moved forward with such regulations, provoking Wall Street’s ire. Morgan Stanley and other brokerage have threatened to pull business from Nevada. New Jersey is accepting public feedback on its proposal.
The SEC did not preempt the state fiduciary movement, as some brokerage executives and trade groups would have liked. But in his remarks, Clayton warned against a regulatory patchwork in state regulations that "will increase costs and make enforcement more difficult."
"I am hopeful that our regulatory colleagues will work to minimize inconsistencies," he said.
It’s unclear if those proposals or the SEC’s Reg BI could face legal challenges, though there is precedent.
The Labor Department’s fiduciary rule, an Obama-era regulation, faced multiple lawsuits from lobby groups representing brokerage, life insurance and other industries. A coalition that included SIFMA, FSI and the Chamber of Commerce successfully killed the fiduciary rule on appeal.
That provided an opportunity for the SEC to fill the regulatory void. But the commission’s proposal was hotly contested, with the commission receiving thousands of comment letters. Lobbying groups gave it a warmer reception than they did the fiduciary rule. Industry insiders were encouraged that, though it uses the term best interest, it doesn’t impose a fiduciary duty on brokers (RIAs are held to such a standard). The proposal also did not favor one business model over another.
But it hasn’t been just investor advocates and Wall Street at odds over broker standards of conduct. Sen. Elizabeth Warren, D-Mass., joined the chorus chiding the commission's proposal. And state regulators urged the SEC to strengthen its proposal.
“The commission should not emphasize how industry can continue business as usual and yet comply with the rule. That is the wrong message to send if the goal here is to enact a standard that eliminates and mitigates conflicts such that investors get the maximum benefit of every dime they save and invest,” the North American Securities Administrators Association said in a comment letter.
“The proper emphasis... should not be on disclosure but rather on the conduct,” NASAA said.
There’s also a possibility that standards of conduct — be they fiduciary, suitability or best interest — could be revisited in a few years’ time.
“I honestly don’t expect this rule to outlast this administration,” Roper tells Financial Planning. “Assuming we get a rule that only gets support from the broker-dealers and is directly contradictory to Congressional intent, I would then assume that as soon as we have a modestly progressive Democrat in the White House, this issue will be reopened.”