Regulatory Outlook | 06.04.19
As Industry Awaits SEC's Advice Standards, Questions, Scrutiny Persist
The Securities and Exchange Commission is finally set to vote June 5 on a multi-faceted framework of advice rules, including the agency’s new signature care standard, "Regulation Best Interest."
More than 600,000 Financial Industry Regulatory Authority (FINRA)-registered industry members – broker-dealers, investment advisers and so-called dual hats – will be impacted by some or all parts of the rules package, depending on their professional designations (as well as on the final version the SEC approves). Soon, though, several thorny questions are poised to be settled. For example, whether the agency is going to move forward with a new standardized disclosure form and, if so, what it will look like.
But even as key details of the regulations finally take shape, there are other accelerating activities in some key states that appear to be taking the debate right back to where it all started – elevating brokers' client-care standards to the level of a fiduciary.
Investment advisers, registered with the SEC and FINRA, of course, are already, and particularly when handling retirement assets, considered to be fiduciaries.
Further illumination on advisers’ status as fiduciaries is yet another piece of the anxiously awaited rules package intended to finally settle an exhaustive, divisive, fiercely contested standard-of-care debate.
Some firms (e.g. wirehouses) have been pushing toward the status quo (brokers bound to a client suitability standard); while others (e.g. independent advisors) have argued for a higher standard for brokers so as to level the regulatory playing field. This decade-long debate has boiled to a head over the past few years and still continues to simmer. A quick recap:
Long and Winding Road
Heading into 2016, the retirement asset advisory industry braced for a new standard to be placed upon certain brokers in specific situations by way of a U.S. Department of Labor rule, known as “the Fiduciary Rule,” first floated by the Obama administration in 2010. The rule, formally introduced in early 2016, sought to redefine with more precision who the DOL considered to be an “investment advice fiduciary,” thereby subjecting a broader spectrum of advisory industry members (i.e. brokers) to fiduciary conduct rules spelled out under the Employee Retirement Income Security Act of 1974 (ERISA).
The net intended result: a higher standard of care for brokers that handled retirement assets; the DOL was in effect overriding the client suitability standard that had previously governed such activities such as an IRA rollover facilitation, raising it instead to the same level as an ERISA-bound fiduciary.
One significant ramification (and a reason the measure was fought against so vehemently) had to do with how client disputes with brokers would be resolved. The DOL rule would have upended FINRA-supervised firms' ability to force such claims into mandatory arbitration proceedings, thus opening the door to civil lawsuits, and at a time when fee-related investor lawsuits against 401(k) plans were mounting.
As soon as the Trump administration took office in 2017, however, the Fiduciary Rule was placed in limbo by way of an executive order that scuttled its implementation. By early 2018, the rule was struck down by the U.S. Court of Appeals for the Fifth Circuit.
In April of 2018 the SEC stepped into the breach, proposing its three-component regulatory framework.
This proposed rules-package included:
- A client-best-interest standard ("Reg BI") for brokers, one widely considered to be a step above the suitability standard but a step below legally bound fiduciary
- A new standardized disclosure, called "Form CRS," that brokers will need to provide to clients or prospects, revealing potential conflicts (e.g. financial rewards for promoting a given product)
- A more formally explicit definition of the fiduciary obligations of registered investment advisers who, as mentioned, are already subject to a higher standard of care
Several specific unresolved questions about these rules – which drew 6,000 comment letters – cry out for clarity. The final version that the SEC is expected to vote on could settle some of these matters or possibly cordon some of them off for further discussion. Here are the issues most in need of resolution:
- At the heart of the new rule is a mandatory disclosure document, Form CRS, summarizing client relationships in a standardized way. What exactly will it look like? How long will it be and how will it be communicated to clients (digitally)?
- SEC Commissioner Jay Clayton has gone out of his way to emphasize that while new rule for brokers is based on fiduciary principles, the agency purposefully avoided using that specific term. In contrast, the SEC’s Investor Advisory committee has since recommended the SEC explicitly say that Reg BI is a fiduciary standard, thus holding brokers and investment advisers to the same levels of accountability. Critics say the SEC has failed to adequately define what it means by best interest. Whether the agency takes up the IA committee recommendation or provides any further clarity remains to be seen.
- Some titles appear to be heading for the scrap bin; brokers, were the rule to pass as proposed, will no longer be able to call themselves advisers or advisors. Might some other titles or jargon be put forth as being off limits? Which ones will be deemed appropriate?
Meanwhile, in something of a wildcard agenda item accompanying the advice rules vote, there is a crucial, highly relevant section of the Investment Advisers Act about to get some long-awaited clarity from the SEC.
It's the section that exempts brokers from registering as advisers if the delivery of [advisory] services is “solely incidental to the conduct of his business as a broker or dealer and who receives no special compensation therefor.”
The SEC has said it will provide interpretation on this linchpin of a phrase. This guidance is a big deal. Whether the SEC makes and publishes a fresh interpretation of the scope of this exemption is now being closely watched. To be tackled, it is worth reemphasizing, is this question: At what point does the giving of advice go from being considered incidental to discretionary and requiring a higher standard of care?
Over the years, the SEC has tried to expand fiduciary exemptions for brokers, while, at the same time, informally treating the exemption as allowing brokers a wide berth to give some advice without necessarily having to register as advisers. Will the SEC now formalize that perceived but not precisely codified lax position? Or toss in a curveball that could augment the agency’s case that it really is pushing toward a higher standard? It's possible that in choosing one path versus the other, the agency could sharpen, or file down, the rules’ regulatory teeth, as far as their oversight of brokers who veer even momentarily into the realm of advisers. Most likely, the wider berth interpretation is be to become formalized, industry members predicted.
Still, it’s worth underscoring how the original SEC proposal made a point to mention the need for the agency to reconsider “the scope of the broker-dealer exclusion with regard to a broker-dealers' exercise of investment discretion in light of both proposed Regulation Best Interest and the proposed Relationship Summary."
Joel Wattenbarger, partner at Ropes & Gray, told Investment News that he expects the SEC could weigh in on whether brokers can still fall under the "solely incidental" language if they exercise investment discretion on a temporary or limited basis.
"These are areas where the industry would like some clarity," Wattenbarger said.
As far as the larger questions that are still looming, there are at least two.
Firstly, after all this time spent waiting for the SEC to issue its advice reform package, momentum appears to be growing for entirely new state-mandated regulatory regimes. Does this movement have legs, and would a decidedly underwhelming final rule from SEC throw open the gates for other states to follow?
It’s certainly possible. Nevada and New Jersey are, regardless of the SEC rules, each pursuing rules that would raise the standard of care for brokers to that of fiduciary. Because it put forth its own fiduciary standard for sellers of annuities, New York is viewed as likely to follow, with California, Maryland and Massachusetts seen as next to fall into line. Lawmakers in these more liberal-minded states have decided to seize on the fiduciary issue as a consumer advocacy battle worth fighting.
"The proposed SEC standard is greater than that of the suitability rule but is less than that of a fiduciary duty," the New Jersey Securities Bureau said recently. "We believe that the SEC's Reg BI does not provide sufficient protection."
Scores of independent financial advisors who tout themselves as unconflicted, legally bound fiduciaries are using this notion of occupying higher fiduciary ground as the clearest way to differentiate themselves from competitors who can’t claim the same.
Combine the potential competitive drag of not being a fiduciary with what eventually could be a rigorous patchwork of new state-level client-care regulatory regimes and there suddenly comes into view at least one more weighty philosophical question for industry members resisting higher fiduciary standards: Might you have won the battle, but lost the war?