Regulatory Outlook | 10.16.18
SEC’s Regulation Best Interest Rule Remains Controversial
The growing consensus among financial services industry watchers — think tanks, lobbyists, watchdogs, thought leaders — is that the Securities and Exchange Commission’s (SEC) proposed Regulation Best Interest (Reg BI) rule package will be introduced in some finalized form later in 2018 or early 2019, and implemented in 2020. The rule is intended to clarify the standard of care expected of advisors. For the industry, the bar for conduct goes higher, beyond mere suitability, but steers clear of the term fiduciary and its fraught connotations. Done deal, right? Not so fast.
The recent confirmation of a fifth SEC Commissioner, 37-year-old Republican Elad Roisman, chief counsel to the Senate Banking Committee, “opens up the possibility for the rule to move forward more quickly," said Barbara Roper, director of investor protection at the Consumer Federation of America.
Meanwhile, the Financial Services Institute’s (FSI) lead attorney, David Bellaire, told attendees of an FSI Forum in Salt Lake City that he wouldn’t be surprised if the SEC carved off and set aside the most controversial component, the four-page disclosure document called the “Form CRS,” from the rest of the rule set to move ahead with the core piece. This would establish a standard of care that generally puts clients’ best interests first.
But in a saga that has already had its fair share of plot twists, there still could be a few more surprises around the bend.
Speed Bump Ahead?
A best-case scenario for proponents of Reg BI is that the commission (now comprising three Republicans and two Democrats) pushes something through before a new (potentially Democratically controlled) Congress convenes.
But the SEC has some paces to put itself through, and the clock is ticking. The agency has some 6,000 comments to digest, and it said it would do some consumer testing of the Form CRS and make the results available, all of which could take time. Some opponents of Reg BI intend to hold the SEC’s feet to the fire on those promised tests, if only to put up a speed bump on the track.
The proposed rule would require broker-dealers (B/Ds) to act in the best interest of retail customers when recommending securities transactions.
Firms would have to meet three obligations:
- Disclosure: B/Ds must disclose key details of the client-broker relationship, including conflicts of interest.
- Diligence and care: Firms must exercise "reasonable diligence, care, skill and prudence" to understand the product they're recommending to clients. They must also have a reasonable basis to believe that this investment, as well as a series of recommended transactions, is in the investor's best interest.
- Conflict of interest: B/Ds must maintain and enforce policies and procedures to identify, disclose and mitigate — or eliminate — material conflicts of interest stemming from financial incentives.
Consumer advocates largely oppose the rule, claiming it ultimately lacks real teeth (i.e., clients are bound by arbitration, so they’re unable to seek meaningful legal action against brokers in cases where harmful or unscrupulous behavior has been alleged).
A top Democrat on the House Financial Services Committee is already taking aim at Reg BI for being ineffective. In a hearing in late September, Representative Stephen Lynch (D-Mass.) called the standard “weak” and hammered home the notion that the SEC had not lived up to the mandate it was given in Section 913 of Dodd-Frank.
At that hearing, Dalia Blass, director of the SEC’s division of investment management, asserted the rules drew from existing concepts — such as the impartial conduct standards from the Department of Labor’s fiduciary rule — and were tailored to apply to the broker-dealer relationship (commission) model. This was done in the interest of preserving greater consumer choices, parroting an industry line and not winning any points with Lynch, who seemed to warn the SEC that they may come to regret pushing through a watered-down regulation.
Citing William F. Galvin’s view of the SEC proposal, Lynch cautioned that a weak rule would force Massachusetts to adopt its own rules to protect investors. Democratic-leaning states, such as New York and California, are already eying a similar stance.
Industry groups, such as the FSI, contend that the rule delivers on finally establishing a uniform best interest standard of care for all professionals providing investment advice to retail clients.
“The principles-based standard described in the proposal adequately provides the ability for it to address the needs of various business models and clients,” the FSI said in its comment letter to the SEC regarding Reg BI.
Said SIFMA: “On balance, the SEC proposal puts regulators, industry and, most importantly, investors, in a much better starting point than where we ended with the DOL rule.”
Rich Blake A veteran journalist based in New York City, Blake has covered the financial world for numerous publications, including Institutional Investor, ABCNews.com and Reuters. Blake was a co-founder and executive editor of Trader Monthly magazine. The Buffalo native is the author of three nonfiction books, including “The Day Donny Herbert Woke Up,” which is currently being adapted into a motion picture. In 2004, Blake was nominated for a National Magazine Award in the Reporting category for Institutional Investor.