As its authority and mission are defined on its public website, the U.S. Securities and Exchange Commission (SEC) holds primary responsibility for enforcing federal securities laws, proposing securities rules, and regulating the securities industry.
This role means the SEC is, in a practical sense, the most important regulator of the nation’s stock and options exchanges, as well as the entities and organizations that provide investment products and services to consumers in the United States. For fiduciary retirement plan advisers, perhaps the only regulator having a greater influence on their daily work is the Department of Labor (DOL), with its responsibility for enforcing and interpreting the Employee Retirement Income Security Act (ERISA).
Given its broad authority, the SEC is normally engaged in a wide range of rulemaking and regulatory activities in any given year—and that has certainly been the case in 2019. For plan advisers, three or four of the SEC’s ongoing regulatory activities should take precedence while planning for compliance in 2020. These are the Regulation Best Interest (Reg BI) package, the new advertising rules for advisers and brokers, and the revised approach to rules and requirements related to proxy voting and the use of proxy advisers.
Regulation Best Interest Is Here
Following the DOL’s fiduciary rule debacle, generally speaking there has been broader support for the SEC to take the lead on a revamped best interest standard for advisers and broker/dealers that will create more consistency across retirement and other retail accounts. Some industry commenters have urged the SEC to coordinate closely with DOL as it fully implements Reg BI next year, suggesting DOL should issue exemptions for financial professionals subject to SEC standards of conduct. Many spoke about the importance of getting positive affirmation that SEC standards of conduct would preempt inconsistent state law standards.
According to attorneys with Stradley Ronon, there are some key concepts that will serve well as a jumping off point for coming into compliance with all the nuances of Regulation Best Interest—and with the various interrelated regulatory projects the SEC is working on alongside its best interest rule, such as the Customer Relationship Summary Form. Notably, the rule treats registered investment advisers (RIAs) significantly differently than it does brokerage professionals.
For fiduciary RIAs, in no particular order, the attorneys emphasize the following concepts: Avoid compensation thresholds that disproportionately increase compensation through incremental sales increases; minimize compensation incentives for employees to favor one type of product over another, especially when it comes to proprietary or preferred provider products; consider establishing differential compensation criteria based on more neutral factors, such as the time and complexity of the work involved; and eliminate compensation incentives within comparable product lines.
The Stradley Ronon attorneys add that there will be areas of minimal, moderate and significant anticipated impacts of Reg BI. Minimal impact areas include the manner in which investment companies are regulated under the 1940 Act; the manner in which investment companies are managed and operated under the 1940 Act; board oversight of investment companies; and prospectus and shareholder communication disclosures. Moderate impact areas include scheduled sales charge variations; use of multiple share classes; distribution arrangements under Rule 12b-1; and clean shares.
Major impact areas, according to the attorneys, will be on individual retirement account (IRA) rollovers; non-cash compensation in connection with sales contests and promotions; compensation that incents the sale of one type of product over another, such as proprietary or preferred provider funds; increased emphasis on sales materials that do not include an actual recommendation; financial incentive conflicts arising from the receipt of revenue sharing or other payments from third parties; integrated fund product lineups specifically engineered to minimize financial incentive conflicts; the recommendation of complex investment company products to unsophisticated retail customers; and continued migration from B/D to adviser models.
As the effective enforcement dates for Reg BI approach in 2020, the SEC is currently fighting litigation filed by several private advisory firms and prominent State Attorneys General, which seeks to delay or outright halt the rulemaking’s implementation. Interestingly, unlike industry litigation filed against the DOL’s now-defunct fiduciary rule, which argued the rulemaking was inappropriately restrictive and severe, the litigation against Reg BI argues the opposite. That is to say, the plaintiffs feel the SEC’s approach to mitigating advisory and brokerage industry conflicts of interest does not go nearly far enough to address the real underlying problems that harm consumers of financial services products.
In a recent conversation with PLANADVISER, Nancy Hendrickson, partner and co-chair of the financial services practice group at Kaufman Dolowich & Voluck, said the smart money is on Reg BI taking full effect in 2020. She said advisory firms waiting to see whether the 2nd Circuit will delay or outright halt the implementation of the SEC’s Regulation Best Interest are wasting precious time.
A New Advertising Landscape
While the fiduciary RIA industry’s reaction to Reg BI is more split, there has generally only been positive feedback for the SEC’s recently proposed overhaul to its advertising rules and restrictions.
As summarized by SEC Chair Jay Clayton, the proposed amendments are intended to update the advertising rules to reflect changes in technology, the expectations of investors seeking advisory services, and the evolution of industry practices.
“The advertising and solicitation rules provide important protections when advisers seek to attract clients and investors, yet neither rule has changed significantly since its adoption several decades ago,” Clayton said prior to the SEC voting to approve proposed new advertising regulations. “The reforms we have proposed today are designed to address market developments and to improve the quality of information available to investors, enabling them to make more informed choices.”
The rule amendments are detailed in summary form on the SEC’s website, and the full rulemaking language is available in the Federal Register. In sum, Clayton explained, the proposed amendments to the advertising rule would replace the current rule’s broadly drawn limitations with more permissive, principles-based provisions. The proposed approach would also permit the use of testimonials, endorsements, and third-party ratings, subject to certain conditions, and would include tailored requirements for the presentation of performance results based on an advertisement’s intended audience.
Also notable, the proposed amendments to the solicitation rule would expand the current rule to cover solicitation arrangements involving all forms of compensation, rather than only cash—subject to a new de minimis threshold. They also would update other aspects of the rule, such as who is disqualified from acting as a solicitor under the rule.
Advisers and other interested parties can submit comments to the SEC during the next 45 days.
In written comments shared with PLANADVISER, Investment Adviser Association President and CEO Karen Barr commended the SEC for its proposal, calling it “a significant step in the right direction.”
“The SEC advertising rule hasn’t been substantively amended since 1961—long before social media, long before the Internet, even before fax machines,” Barr says. “We’ve been urging the SEC to update the rule for nearly 20 years. Advancements in technology and communications have drastically changed the ways that every service provider in our economy engages with clients and prospective clients.”
Barr and others have argued that, because of the SEC’s outdated rule, investment advisers are generally prevented from using communications and marketing methods that long ago became standard business practice elsewhere in the economy.
Major Shift in Proxy Voting
Back in August, the SEC adopted new guidance “intended to clarify advisers’ proxy voting responsibilities.” While less directly relevant to retirement plan advisers compared with Reg BI or the new advertising rules, the new proxy voting standards are also important to understand as advisers go about their daily duties.
The complex set of guidance addresses a host of issues related to proxy voting and the providers and users of proxy voting advice. Early reactions to the SEC guidance by investment adviser advocacy organizations were somewhat unfavorable and voiced dissatisfaction about the fact that the guidance was crafted without the opportunity for public comment and without an accompanying economic analysis.
According to the SEC Fact Sheet summary, the guidance discusses, among other matters, the “ability of investment advisers to establish a variety of different voting arrangements with their clients and matters they should consider when they use the services of a proxy advisory firm.”
Perhaps most importantly, the Commission issued an interpretation that proxy voting advice provided by proxy advisory firms generally constitutes a “solicitation” under the federal proxy rules. This development seems to suggest, in essence, that proxy advisory firms are, by providing their advice, not simply delivering objective information to a third party but are, in fact, appealing to the client to vote in a certain way. This in turn means the proxy voting firm must meet a set of specific responsibilities in terms of the accuracy and intentions of its recommendations. To this end, the SEC also provided related guidance about the application of proxy antifraud rules to the provision of proxy voting advice.
The SEC’s move is significant for investment advisers, but the guidance overall seems to be even more meaningful for providers of proxy voter services. One company providing such services is Institutional Shareholder Services (ISS)—which became the parent company of PLANADVISER at the start of 2019.
In a written statement, Gary Retelny, ISS president and CEO, offers his take on the SEC guidance: “ISS appreciates the time and effort spent by the SEC Commissioners and staff to gauge perspectives of varied corporate governance constituencies, including through hosting of the November 2018 Proxy Advisors round table. We will carefully review the guidance, approved today along a party line vote, to understand the potential impacts for our clients as well as to consider further actions that could improve the ability of our clients to meet their fiduciary obligations in a cost effective manner. However, we are deeply concerned that aspects of the guidance may significantly undermine our ability to deliver independent, timely and accurate data, research, insights and perspectives to aid in the discharge of our clients’ fiduciary duties. We will have more to say once we have the opportunity to closely study the guidance.”