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SEC rule would create distinct but 'comparable' regimes for RIAs and broker-dealers

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The SEC is trying to avoid a wholesale disruption of brokerage industry, but firms could face a major overhaul of their compliance programs should the regulator's proposed best interest standard for brokers become rule.

That's the view of attorneys at the law firm Stradley Ronon, who this week offered a fast-out-of-the-gate analysis of the new package of SEC proposals.

"It seems like the proposals — if adopted — likely would have a lasting and material impact on broker-dealers' operations and compliance," Lawrence Stadulis, co-chair of Stradley Ronon's fiduciary governance practice, said during an online presentation. "We don't really see it necessarily as characterized as a sort of status quo. They would not simply clarify existing SEC and FINRA requirements."

The new regulatory regime would for the first time codify brokers' responsibility to put clients' interests ahead of their own, and compliance slip-ups in that area could lead to regulatory enforcement actions, Stadulis observes. Brokers would need to make specific new disclosures around material conflicts of interest and implement policies and procedures to mitigate conflicts — if not eliminate them altogether.

"Collectively, the requirements potentially have sharp teeth because they would establish a tangible, evidentiary audit trail for the SEC and FINRA to follow in determining whether brokers have complied with both the letter and spirit of the best interest standard," Stadulis said.

The SEC also proposed a new disclosure form requiring brokers and advisors to provide a brief summary of their relationship with clients. The regulator also suggests that brokers should not be permitted to use the term "advisor" or "adviser" to describe their services unless they are acting as fiduciaries under the Investment Advisers Act.

However, the provision addressing the use of titles could have limited effect as it only applies to brokers and their associated persons, leaving open the prospect that other financial professionals (i.e. banks, insurance companies, municipal advisors, commodity trading advisors, etc.) could still call themselves "advisors."

"A lot of people have said this is going to give rise to a whack-a-mole problem, and it does seem like since everybody except broker-dealers could still use 'advisors' that that's very likely to be the case," said Stradley Ronon counsel John Baker.

To be sure, the SEC's proposals are a long way from becoming final rules. Based on the critical comments offered by commissioners at last week's meeting — where they voted 4-1 to formally consider the proposed rules — many observers believe that they will need to undergo substantial revisions before they could win final passage.

The commission is holding a 90-day comment period on the proposal, and will be counting on comments to flow in from brokers, advisors, investor advocates and other voices.

"They all really want public engagement that informs policy choices," said David Grim, a partner at Stradley Ronon and a longtime SEC veteran who recently stepped down as director of the agency's Division of Investment Management.

In particular, commissioners will want to hear about the concrete impact the proposals would have on brokers and advisors' practices — how they could change client relationships, limit the menu of products available, or lead to any changes in the cost and quality of advice, Grim said.


In drafting the new rules, the SEC explicitly avoided going the route of a uniform fiduciary standard that would extend the advisor compliance regime to brokers.

Instead, the SEC is proposing a preservation of the "separate and distinct conduct standards and compliance mechanisms" for brokers and advisors, according to Stadulis.

"Consequently, financial services firms that conduct their businesses through dual or affiliated IA and BD registrants would continue to understand and meet these different conduct standards," he said. "In other words, there's not going to be uniformity here and it's important to understand the separate regimes and how they work."

But the new best interest standard nonetheless represents a consequential change that would elevate the standard of conduct for brokers to a level that might be seen as on par with the advisors' fiduciary standard, Stadulis argues.

"The proposals would, as a practical matter, [impose] reasonably comparable conduct standards on [brokers] when providing personalized investment advice and recommendations to retail customers," he said.

However, investor advocates would disagree with that analysis. Some have argued that the SEC's proposal amounts only to a modest expansion of brokers' current suitability obligations, falling short of a full-fledged fiduciary standard.

Advisors should expect more regulatory requirements, enforcement actions and uncertainty in 2018, experts say.
December 11

Sen. Elizabeth Warren (D-Massachusetts) echoed those concerns in a statement responding to the SEC's proposal, saying that it "will do little to help families losing billions of dollars a year to conflicted financial professionals."

"[T]he proposal doesn't clearly require brokers to put their client's interest first or eliminate obvious conflicts of interest," Warren says. "The commission must prohibit these bad practices and give investors the ability to enforce their rights if it's serious about protecting working families."

Indeed, the SEC's proposal leaves the term "best interest" vague in its proposal, the Stradley Ronon analysis finds. Moreover, the best interest regulation does not take aim at any specific product or compensation structure, leaving open the door for commissions, differential compensation packages and proprietary products, provided the broker makes requisite disclosures and adopts appropriate mitigation policies.

That approach marks a departure from the one taken by the Department of Labor in its 2016 rule imposing a fiduciary duty on advisors working with retirement accounts.

The DoL regulation, which the brokerage industry resoundingly opposed, is in a legal limbo now, after a federal appeals court struck down the rule and the department mulls its next steps. But even if the DoL abandons the legal defense of its fiduciary regulation, it still maintains authority in the retirement space, according to George Michael Gerstein, co-chair of Stradley Ronon's fiduciary governance practice.

"The Department of Labor is not going to cede its jurisdiction to the SEC. The Department of Labor has clear authority to regulate the retirement space, they will continue to do that. That's been abundantly clear over the years," Gerstein said. "The SEC is not replacing the Department of Labor."

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