Independent wealth managers and watchdogs seek clarity from the SEC

Independent wealth managers are bashing an SEC program that ended in 2020 as they resist a new one they fear will be a threat to the way they do business this year and beyond.

The questions and rifts among regulators, industry CEOs and fiduciary reformers took center stage at the Financial Services Institute’s OneVoice Conference this week. The trade and advocacy group representing 90 firms and 30,000 independent financial advisors warned that 2022 could bring even more regulatory enforcement cases under the SEC’s Regulation Best Interest.

As evidence of the potential harm, they slammed nearly 100 settlements with the SEC in the past three years by wealth managers accused of not adequately disclosing conflicts of interest in their mutual fund share-class recommendations. FSI characterized the cases as burdensome to firms and pointless for clients who received small restitution payments.

Two major FSI members are currently fighting the SEC in court over similar cases. To FSI CEO Dale Brown and executives on the panel from Raymond James Financial Services, Lincoln Investment and Stifel Independent Advisors, the SEC disclosure cases signal uncertainty about what Chair Gary Gensler’s team plans to do with Reg BI.

While FSI supports the rule in its current form, critics such as state regulators and fiduciary advocates are calling on the SEC to crack down more on industry conflicts they say are not in a client’s best interest. For example, they point out that the 100 cases charged wealth managers with placing their clients in higher-priced share classes of mutual funds without properly explaining the incentives they receive from asset managers and clearing firms for doing so.

Brown rejects that view: “The message to the client is, ‘The SEC requires us to tell you that we're crooks, and here's $2 to prove it,’” Brown said.

He was responding to Lincoln CEO Ed Forst’s concern that the case against his Fort Washington, Pennsylvania-based firm “almost looks like it's intentionally making us look bad when, in fact, we're a helping profession.”

With other comments from Raymond James Independent Contractor Division President Jodi Perry that regulations like Reg BI are “a thousand pages, and you're left to interpret it” and a remark from Stifel Independent CEO Alex David that the SEC and FINRA are “making decisions and asking questions later,” the panel took on the appearance of a group of like-minded friends talking politics around a fire.

Forst, the current chair of FSI’s board, made a gruesome analogy and took a political swipe at the prospects for President Biden’s allies in Congress in this year’s midterm elections. He predicted that “the noose is going to be tightened” and that the SEC will “come after us” this year because “I don't think there's a lot of time left in the power that they have in Washington.”

“They'll use Reg BI. They won't change the words, they'll just change the interpretation of it,” he said. “We had an SEC audit, and we just got a letter. So we're trying to find out whether this audit letter was unique, was it not unique, where was it unique? Because it looked like we didn't do anything. And we've done a lot. So we'll see. It's the next step. And if we're not going to learn from regulation by enforcement, if we're going to move away from that, then we have to learn before enforcement. Whatever clarity we're going to get from the regulators has to happen before enforcement, which is now. So it's tough, and that's why we're here.”

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‘Worst of both worlds.’
In fact, state regulators issued a report in November explaining why they believe brokerages and wealth managers haven’t changed their practices very much in the wake of Reg BI going into effect in 2020 and exactly how the firms should shift them to comply with the rule. And the self-reporting program that ended that year after nearly 100 settlements provided a combined $139 million in restitution, even if certain individual clients only received a small amount.

Additional cases among firms that didn’t participate in the voluntary program are sending millions more dollars in restitution to clients who were, according to the SEC, paying unnecessarily high fees on their mutual funds without adequate disclosure. Citing these kinds of cases, one academic researcher has referred to the dual registration structure used by most large wealth managers as brokerages and RIAs as “the worst of both worlds.”

Still, FSI isn’t alone in seeking greater clarity from the regulator about Reg BI. Beyond hiring longtime investor advocacy champion Barbara Roper of the Consumer Federation of America as a senior advisor to Gensler in August, the SEC hasn’t said how it might alter any aspect of Reg BI or shared much in the way of concrete tips for the industry. Representatives for the SEC declined to comment on the remarks of the CEOs at FSI’s conference, instead referring Financial Planning to Gensler’s congressional testimony last May.

“We want to ensure that, when providers of investment advice work with retail customers, their advice is genuinely in the ‘best interest’ of those customers,” Gensler said. “The SEC staff will implement the rule in ways that will maximize investor protection. At the same time, we are keeping an open mind about what guidance or other updates, if any, may be needed to ensure that broker-dealers fully understand the rules and that Regulation Best Interest lives up to the promise of its name.”

The independent wealth managers fear that any moves by Gensler’s team will threaten their business models, which include practices like the 12b-1 marketing and distribution fees at issue in the 100 cases, according to Knut Rostad, the president of the Institute for the Fiduciary Standard. FSI’s continued campaign against so-called rulemaking by enforcement displays “a complete disdain for very basic fiduciary principles,” Rostad said in an email. He and other fiduciary advocates argue that the SEC must strengthen Reg BI in a way that protects clients’ interest more than the prior suitability standards governing brokerages’ recommendations.

“The SEC has boasted that ‘best interest’ was NOT defined, or that ‘mitigating’ conflicts has no concrete meaning beyond disclosure,” Rostad said. “Barb Roper repeatedly pointed out, before joining the SEC, that the SEC has not offered a single example where Reg BI required something not also required of the suitability standard. Implementing Reg BI should mean providing meaning to ‘best interest’ and ‘mitigation,’ and then starting to enforce what those meanings require in process, procedures and practices.”

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Court filings under the radar
Just as in its previous advocacy efforts in opposition to the Obama administration’s fiduciary rule, FSI is digging in against this potential enforcement wave through court filings in SEC cases that are proceeding slowly out of the limelight against member firms Commonwealth Financial Network and Cetera Financial Group’s Cetera Advisor Networks and Cetera Advisors. Though largely forgotten by the wider industry after the SEC filed the cases in 2019, the proceedings revolve around the regulator’s allegations that the firms didn’t adequately disclose the conflicts to clients from their tens of millions of dollars in revenue sharing, 12b-1 fees and markups on mutual funds. Neither case has reached the trial phase. FSI has filed “friend of the court” briefs stating its position in both cases, despite objections from the SEC.

“If the SEC is successful in this action, a new standard of general applicability would become effective without going through the formal rulemaking process — which will result in widespread ramifications to the financial services industry,” according to the FSI brief from Commonwealth’s motion in November to file the document in the Boston federal court case.

“The expanded duties of disclosure would substantially increase the operational and compliance costs of investment advisers, perhaps prohibitively so, and such costs would ultimately fall on the investing public,” the document states. “Even more so, the stage would be set for the regulated financial services industry to be subject to new requirements and changing standards for which adequate notice and an opportunity for comment is not provided.”

In a pretrial ruling from August 2020 in the Cetera case out of Denver federal court, the judge allowed a nearly identical brief from FSI to be filed in the case over opposition from the SEC. In the Commonwealth case, the regulator filed a motion seeking to block the filing of FSI’s brief as well. FSI didn’t provide any basis for suggesting there would be higher expenses if the case is successful or file its proposed amicus brief until more than two years after the regulator charged Commonwealth, according to the SEC lawyers. The regulator has filed a separate motion for summary judgement in the case as well.

“The Commission now faces the prospect of being required to rebut FSI’s dubious legal and factual arguments (without the benefit of discovery) about matters that were not raised by the parties,” the SEC said in its filing. “FSI’s belated participation would inundate the court and the parties with new briefing on collateral and irrelevant issues, make an end-run around discovery limitations, interfere with the summary judgment briefing schedule and overall increase the cost and burden of this case for all involved.”

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What happens next?
Regardless of the lengthy court fights and strong words emanating from the decades-long debate about the guidelines dictating advisors’ duties to their clients, this year will likely bring some degree of answers to the complicated questions. As for the CEOs, they say their main concern is simply trying to stay up to speed with all of the developments. Stifel’s independent arm went through David’s first FINRA examination since taking over as CEO last year, which was “a little bit less” intensive as a process than he expected, he said on the panel.

“Coming into 2022, we have been trying to learn from that; reach out to our regulators on a proactive basis as much as we possibly can to help them to understand where we're trying to take the business,” he said. “We've had at least two conversations around [the fact] that we had a business that's been around for 30 years, and this is where we're trying to take it. These are the expansion models that we have in place. And they seem to like that.”

At Raymond James, the firm is just “trying to stay ahead of the curve, whatever that means these days,” Perry said. The firm examines the guidance put out by FINRA and the SEC about their main areas of focus and then huddles with its internal audit group “just to make sure that they're really checking things out to see if we have any gaps that we can prepare for,” she said.

“But, of course, I think it's really difficult because the new rules that come out are huge,” Perry said. “It feels almost like they're intentionally gray in some way. So the best thing you can do is keep asking those questions and try to present what you're trying to do, and at least make them feel like you're trying to be on the same page with them so you're not in these adversarial relationships with regulators.”