It’s Not Déjà Vu, It’s a Brand New Best Interest Rulemaking Debate

The release of a thousand-page "best interest" rulemaking package by the SEC applying to all brokers and investment advisers is being hailed as a victory by some and a deep disappointment by others; either way, it's the start of another long chapter in the epic industry battle over federal conflict of interest regulations. 

Ushering in what will likely feel like a case of serious déjà vu for retirement industry watchers, the U.S. Securities and Exchange Commission (SEC) on Wednesday introduced a multi-pronged set of new impartial conduct standards and disclosure requirements that will apply to both financial advisers and broker/dealers serving “retail clients,” which in the eyes of the SEC includes retirement plan participants.

Almost immediately following the vote and throughout the day on Thursday, retirement advocacy and lobbying organizations began sending commentary about the new proposal. While most acknowledge the rulemaking is subject to an extensive comment period and will likely change substantially before it is ever adopted, there are some clear themes already emerging in the retirement plan industry’s various reactions. Most notably, many of the same groups that supported the Department of Labor’s (DOL) now-defunct effort to strengthen the fiduciary standard applying to advisers of retirement plans and individual retirement accounts (IRAs) under the Employee Retirement Income Security Act (ERISA) view this new proposal from the SEC as being somewhat toothless.

Duane Thompson, senior policy analyst at Fi360, suggests the release of “a thousand-page package by the SEC in lieu of a uniform fiduciary standard applicable to investment advice by brokers and investment advisers is very disappointing, but not a surprise, given earlier reports that the Commission was leaning toward a ‘suitability-plus’ standard for the brokerage industry.”

Thompson argues the SEC Chair Jay Clayton’s premise that existing business models should drive market conduct standards, “rather than fiduciary accountability in relationships based on trust and confidence for identical advisory services,” is flawed. 

“Moreover, the limited restriction on use of ‘advisor’ and ‘adviser’ titles only to fiduciaries falls short by allowing the use of other titles, such as ‘wealth manager’ and ‘financial planner,’ to be available for non-fiduciary advice,” he suggests. “Finally, there appears to have been little effort by the SEC to harmonize its rulemaking with the Department of Labor, where a decision to appeal the Fifth Circuit decision on its own fiduciary rule still remains pending.”

Like others, Thompson stresses that his organization still needs time to comb through the massive rulemaking proposal to confirm these initial impressions.

“Our immediate reaction leaves us in full agreement with Commissioner Stein’s comments during the open meeting yesterday that the SEC squandered a golden opportunity to act in the best interest of investors,” Thompson says. “We intend to submit constructive, detailed comments to the Commission in the near future and trust that it will make substantive changes to vastly improve the current regulatory package.”

Additional commentary from Blaine Aikin, Fi360 Executive Chairman, highlights how brokers that would have been fiduciaries under the DOL rule “will fall down to a new non-fiduciary Regulation Best Interest standard that brings with it quasi-fiduciary versions of the duties of loyalty and care.” Sounding a note of optimism for supporters of a stronger fiduciary standard, he predicts the new model suitability rules coming out from insurance regulators could more closely track the DOL’s Impartial Conduct Standards, “with more robust fiduciary characteristics than are found in this first stage of the SEC’s rulemaking.” 

“While disappointing that investors will continue to receive advice from both fiduciary investment advisers and non-fiduciary brokers, the bar for both has been raised, marginally for advisers, and according to the SEC, materially for brokers. Of course we won’t know how high the bar has been raised until a final rule is adopted,” Aikin concludes. 

Similar comments were shared by William Galvin, Massachusetts Secretary of the Commonwealth, who is known for actively commenting on and policing broker/dealer conflict of interest issues. In his early commentary, Galvin argues the proposed rulemaking “appears to be drafted to appease the broker/dealer industry and their lobbyists, protecting the industry’s best interests instead of the best interests of investors.” He further posits that the DOL fiduciary rule remains a superior approach to accomplishing the SEC’s stated goals of alleviating investor confusion and service provider conflicts of interest.

“Among other problems, the rules do not prohibit conflicted actions and will provide support for recommendations of high-cost and proprietary investment products, where conflicts have been particularly harmful to retail investors,” he claims. “Crucially, the term ‘best interest’ is not defined in the rulemaking package. This ambiguity will lay the groundwork for the same debates and litigation that exist today under the ‘suitability’ standard that applies to broker/dealers.”

It should be stated that, during the SEC’s open meeting to introduce the rulemaking package, staffers repeatedly stated the proposals would be strong enough to prevent advisers and B/Ds from placing their own financial incentives ahead of client interests. Among other avenues, the proposal will seek to require non-fiduciary brokers to more directly consider the cumulative costs associated with their commission-based sales to retail clients—and to prevent and address any non-best interest churning or other behaviors that result in sub-optimal outcomes for retail clients.

Some more positive commentary was shared by the Insured Retirement Institute (IRI), which is in a way unsurprising, given the group’s outspoken opposition to the DOL fiduciary rule—argued on the basis that the DOL fiduciary rule was unfair to the annuity sales industry and the fact that IRI has called for SEC to take the lead on improving the regulatory framework controlling broker/dealer sales behavior. Writing to PLANADVISER, IRI Senior Vice President and General Counsel Lee Covington commends SEC Chairman Jay Clayton and his fellow Commissioners, “as well as the hard-working and dedicated SEC staff, for taking this critical first step towards establishing a best interest standard for financial professionals.” 

“We are particularly appreciative of the Commission’s commitment to collaborating with their counterparts at the DOL, FINRA [Financial Industry Regulatory Authority], and the state insurance and securities departments around the country to develop a cohesive and consistent regulatory framework,” Covington says. “IRI looks forward to reviewing the details of the proposals with our members and engaging constructively with the Commission in the coming weeks and months.” 

Brendan McGarry, an attorney at Kaufman Dolowich & Voluck, shared some more technical interpretation. He has the sense that the SEC’s proposal for a “best interest” standard for broker/dealers “will likely continue to receive criticism from proponents of the DOL Fiduciary Rule as being too lenient.”

“The proposal may also receive criticism from industry participants as being too vague regarding the definition of best interest,” he expects. “The SEC’s proposal to provide further guidance regarding the definition of fiduciary for investment advisers leaves open the possibility that the ‘best interest standard’ and ‘fiduciary standard’ will ultimately be similar, but the separation of those two proposals gives the impression that they are not, in fact, the same. Maintaining the separation between standards for broker/dealers and investment advisers, while calling the standard for broker-dealers ‘best interest,’ will likely garner a large amount of comments and may create further confusion in the industry as to what exactly ‘best interest’ means.”

According to McGarry, the proposed requirement of a new SEC disclosure document, called Form CRS, for client relationship summary, is a requirement that the DOL Fiduciary Rule did not include and would be an additional disclosure for broker/dealers than is currently required. He expects investment advisers will likely try to subsume this into their Form ADV, Part 2a brochures, but the information released so far by the SEC makes no mention of whether this will be allowed in practice.

“Based on the commissioners’ comments, the proposed 90-day comment period may not be long enough to facilitate generation, submission and consideration of the number of comments likely to be submitted for the 1,000 page rule,” McGarry concludes. “The proposed limitations on the use of the term ‘advisor’ may cause some broker-dealers and/or their associated persons to change their titles or names, but is not likely to require a change in business models, itself.”