The Subcommittee on Investor Protection, Entrepreneurship and Capital Markets of the U.S. House of Representatives convened a hearing Thursday morning to debate the merits of the Securities and Exchange Commission’s Regulation Best Interest proposal.
The hearing, titled “Putting Investors First? Examining the SEC’s Best Interest Rule,” featured five speakers from the financial services industry. They were Susan MacMichael John, CFP chair, Certified Financial Planner (CFP) Board of Standards; Dina Isola, an investment adviser representative for Ritholtz Wealth Management; Barbara Roper, director of investor protection, Consumer Federation of America; Lee Baker, president, AARP Georgia State; and Harvey Pitt, CEO of Kalorama Partners and a former SEC Chairman, serving from 2001 to 2003.
All of the speakers apart from Pitt shared negative commentary about the SEC’s approach to mitigating conflicts of interest in the advisory and brokerage industries. They argued that Regulation Best Interest does not go far enough to clarify the differences between advisers and brokers, nor far enough to ensure that brokers put the interests of their clients ahead of their own financial incentives. Pitt, for his part, commended the SEC for taking on such a monumental task “thoughtfully and creatively.” He called the draft form of Regulation Best Interest a “positive first step,” one which can and should be built on by the SEC in the years ahead.
Kicking off the hearing, subcommittee chairwoman Carolyn Maloney, D-New York, recalled some of the history that has driven the SEC to put forward Reg BI. As she explained, the debate about a uniform fiduciary standard is nothing new.
“When we were writing the Dodd-Frank law, there was a huge debate about whether to establish a uniform fiduciary rule,” Maloney recalled. “In the House version of the legislation, we did in fact move to subject brokers to the same fiduciary rules advisers are subject to. We said SEC should write these rules immediately. On the other hand, the Senate decided SEC should first do a study, and then if the SEC study found that a uniform duty is appropriate, the SEC must then write a rule within two years.”
After significant debate, the final version of Dodd Frank required SEC to conduct a study and then simply authorized (as opposed to required) the SEC to make a rule afterwards.
“In 2011, the SEC submitted a 208-page report recommending that the SEC put a uniform standard in place for brokers and advisers,” Maloney said. “As we know, this still has not happened. The delay in getting a rule put in place is costing retail investors millions of dollars investors each and every year. This is why the Department of Labor stepped in and put out its own rule, which would have established a strong fiduciary duty for brokers and advisers, but the industry filed numerous lawsuits. And even though the rule was upheld in most courts, a single appellate court struck it down nationwide. And out of political spite, the Trump administration refused to appeal the decision and to support the authority of its own Department. That brings us to the SEC’s current rulemaking. It is still far too weak in my opinion. I have serious concerns.”
According to Maloney, despite the SEC’s staff recommendation to create a uniform fiduciary duty, Regulation Best Interest falls far short of this.
“Reg BI does not create a full fiduciary duty for brokers,” Maloney said. “Instead, brokers have to act in the ‘best interest of customers,’ which sounds good, but the rule does not even define what this means. In fact, the rule allows brokers to continue to take their own financial interest into account when making client regulations. They can remain conflicted as long as they offer some basic amount of disclosure. This is dangerous for investors.”
For this reason, Maloney said she supports a bill being introduced in the House, dubbed the “SEC Disclosure Effectiveness Testing Act.” Among some other requirements, the bill would essentially force the SEC to conduct further user testing of the disclosures required under Reg BI, and to use the results to craft a more effective conflict of interest mitigation approach.
After Maloney, the ranking Republican member of the subcommittee, Michigan Republican Bill Huizenga, spoke more favorably about the SEC’s Regulation Best Interest. He said the now-defunct DOL fiduciary rule “was a significant regulatory overreach that would have added cost and cripple investor choices.”
“To me, it is clear the SEC is the right regulator to take on this project, per Dodd-Frank,” Huizenga said. “Chairman Clayton has repeatedly said the package is designed to serve main street investors. It is a best interest standard and clarifies the fiduciary duty owed by investment advisers to their clients. And brokers and advisers will both have to state clearly all their financial incentives.”
Huizenga agreed with his Democratic colleagues that Regulation Best Interest could be improved, and he said he expects the SEC will take into account the concerns of the hearing witnesses and other stakeholders.
“Let me be clear, the proposed Reg BI is not perfect,” Huizenga said. “But it is also clear that the SEC is taking direct and meaningful steps to listen to everyone as part of this process. The commission has held seven roundtables and has contracted the RAND Corporation to do user testing of disclosure forms. They are taking this very seriously.”
Witnesses strongly oppose Regulation Best Interest
The full transcript of each witnesses’ testimony is available for download here, as is the text of the SEC Disclosure Effectiveness Testing Act.
The first witness to speak was Dina Isola, the adviser with Ritholtz Wealth Management. She recalled working at the beginning of her career at a brokerage firm, prior to her move to become an actual fiduciary adviser.
“At that first brokerage firm I saw clearly some very big problems,” Isola said. “Brokers’ recommendations were and are still today directly tied to their personal financial incentives. I saw how brokers scramble to generate business at month’s end, and how increasing sales could be a matter of being fired or promoted. Sales quotas were hung over brokers’ heads. Product-specific pushes were a routine occurrence. The firm I worked at expected 75% of sales to come from affiliated funds.”
Isola said these perverse incentives made it a common occurrence for brokers to overlook investors’ best interests.
“Since I left the brokerage industry, nothing has changed in this respect,” she said. “These incentives reward bad advice that harms investors. Under the law, brokers engage in harmful conflicts of interests while misleading regulators, customers and lawmakers by acting like trusted advisers.”
Isola suggested the problem is particularly acute in the 403(b) market.
“Countless investors would be better off under a stronger fiduciary standard,” she concluded. “No reasonable person would consent to conflicted financial advice if they really understood this situation. Brokers are not bad people, but they are caught up in a web of perverse incentives. I believe that anyone who wants to hold themselves out as a trusted adviser must put client interests first, above everything else. All others should be called salespeople. If that’s a distasteful title to you, you should reconsider your business model.”
Speaking next, Susan MacMichael John of the Certified Financial Planner Board of Standards echoed many of those sentiments, though she did not speak as aggressively about brokers.
“CFP Board’s mission is to benefit the public,” she said. “Today, more than 83,000 CFP professionals already provide fiduciary services, and their clients benefit from flexible service models and broad access to investment products and services of all types.”
CFP Board first adopted a fiduciary standard for its registered members in 2007, requiring professionals to act as a fiduciary when doing personal financial planning. Last year, CFP Board revised its code of standards and conduct once again, such that the new standards provide clarity by extending the fiduciary duty to all forms of financial advice, not just personal planning.
“We did this in large part because investors tell us they cannot distinguish sales people from advisers, and that they believe all providers should be required to work in their best interest,” John said. “We appreciate Reg BI as an opportunity to take a step forward, but we fear that it is just giving an appearance of protection and not a genuine solution to protect investors. We hope the rule can be strengthened.”
After John, Barbara Roper (from the Consumer Federation of America) again took brokers to task.
“Addressing brokers’ conflicts of interest has been a priority of our organization for many years,” she said. “We’ve been pushing them since the early 90s on this topic, in fact. Under President Trump, the SEC has instead unleased broker/dealers to masquerade as serving clients’ best interest. The SEC has proposed a weak, disclosure-based system, even after Congress gave the SEC the express authority to create a strong fiduciary standard. This is unacceptable.”
According to Roper, on first glance, Regulation Best Interest may seem to offer at least modest progress.
“But upon closer inspection it is clear that Regulation Best Interest would do far more to weaken investor protections than to strengthen them,” Roper said. “The Best Interest standard doesn’t require brokers to recommend products they know will drive the best outcome for clients. This is a huge omission. Industry groups are taking this lack of clarity as confirmation that pretty much anything and everything will be considered acting in the client best interest, so long as disclosure occurs.”
Roper went on to call the rule unenforceable and ill-conceived, though she does seem some positive areas as well.
“One positive potential is the requirements for firms to identify and take steps to mitigate financial conflicts of interest,” Roper said. “But sadly there is no system for measuring any of this or enforcing any of this, or defining any of this. As a result, a rule that appears at first glance to offer promise does little more than to codify the existing, very weak standards. It will also deprive investors of critical common law protections they enjoy today. For all these reasons, we strongly support the SEC Disclosure Effectiveness Testing Act. Form CRS is a disclosure disaster and must be rethought fundamentally.”
The next speaker, Lee Baker at AARP Georgia, continued the attack against Regulation Best Interest. Like John, Baker took a more friendly approach to criticizing the SEC’s approach, suggested the rulemaking package could be strengthened.
“At the AARP, we push for a uniform standard that resembles the state trust definition of best interest,” Baker explained. “This definition requires financial services professionals to act with the care, skill and prudence that would be displayed by an independent expert. Anything short of this standard opens up older Americans to be the targets of abuse and fraud. Every year, we continue to hear so many stories from our members about fraud and members being harmed by conflicted advisers and brokers. We need regulators to create a level and transparent market.”
Baker added that Form CRS is a decent start, but it should be simplified.
“We’ve done two rounds of our own user testing and we can see clearly that real people do not understand these disclosures,” Baker said. “They struggle with understanding it in any detail. For that reason, disclosure does not shield investors from harm in itself. We need a standard that prohibits incentives that are perverse, otherwise it’s going to be a best interest standard in name only.”
Last to address the committee was former SEC Chairman Harvey Pitt. As a Republican and former leader of the regulator in question, Pitt took a markedly different tone in his testimony. He urged his fellow witnesses to realize that Regulation Best Interest is a strong first step that can be built upon by the SEC in coming years.
“Today’s testimony is rightly impassioned and shows this is not an easy subject for anyone,” Pitt said. “There are widely desperate views that are held forcefully and firmly on this subject. I believe this is a good thing, because eventually it will produce the right results. Of course it’s going to be challenging to get there.”
Pitt said he believes Regulation Best Interest, as proposed, does improve the existing consumer protection system.
“The worst enemy of a good proposal is a perfect one,” he said. “Everyone must keep in mind where we are in this process. The SEC has put out a thoughtful and creative proposal. Regulation Best Interest is still in the process of being finalized. Today’s hearing and all the thousands of submitted industry and consumer group comments will be useful to the Commission in finalizing its rule. I believe this proposed regulation should be seen as an initial step, not as a final step.”