The Securities and Exchange Commission (SEC) under President Donald Trump has settled on a disclosure-based approach to policing conflicts of interest in the retail investment marketplace; the securities regulator also published an updated interpretation of key sections of the Advisers Act.
During a much-anticipated meeting held Wednesday morning in Washington, the SEC voted in favor of adopting a final amended version of the Regulation Best Interest rulemaking package.
In the words of Chairman Jay Clayton, the SEC has adopted an ambitious new system to establish a higher standard of conduct for broker/dealers and their representatives when making a recommendation to a retail customer of any securities transaction or investment strategy involving securities. Critics of the rulemaking effort, including consumer advocates and SEC members appointed by the previous president, say the disclosure-based approach is insufficient to protect novice investors.
During the SEC meeting, staff highlighted that the rulemaking includes key enhancements over broker/dealers’ current obligations. Importantly, the updated rulemaking will apply a best-interest standard to account recommendations, they said, including rollovers from retirement plans into individual retirement accounts (IRAs), and recommendations to open particular types of accounts. The rulemaking as amended also explicitly requires best interest care from brokers, meaning brokers cannot put their own financial interest ahead of the client’s when making a recommendation.
In addition to Regulation Best Interest itself, the Commission voted to approve an updated version of the Customer Relationship Summary Form, or Form CRS. This was another area of disagreement both during Wednesday’s meeting and since the publication of the proposed version of Reg BI and Form CRS back in April 2018. The SEC’s majority has for its part published favorable user testing of Form CRS, which both as proposed and amended requires registered investment advisers and registered broker/dealers to provide a brief relationship summary to retail investors. This summary must make clear any potential conflicts of interest a broker or adviser may face, and it must detail their forms of compensation and incentives.
Consumer advocacy groups say their own qualitative user testing shows investors would not significantly benefit from Form CRS. In fact, they said, the forms, as mocked up by the SEC, may even be actively misleading.
Updated Standard of Conduct
Wednesday morning’s action also included a vote to publish an updated Commission interpretation of the general standard of conduct for investment advisers, as well as a vote in favor of publishing an updated interpretation of the “solely incidental prong of section 202(a)(11)(C) of the Investment Advisers Act of 1940.” This is the section of the law that sets the line in terms of how much individualized guidance a broker can give before stepping over the line into becoming an adviser—thereby triggering the greater fiduciary duties owed by advisers to their clients relative to brokers.
During his remarks opening the meeting, Chairman Clayton emphasized that he does not think a “one-size-fits-all” approach could work for policing both advisers and brokers across all retail markets. He said the SEC’s new approach has benefited from the lessons learned during the adoption and subsequent vacating of the Department of Labor fiduciary rule designed under the Employee Retirement Income Security Act (ERISA). He said the new model is designed specifically to allow for the continuation of commission-based fee models.
“Regulation Best Interest includes fiduciary principals but is appropriately tailored,” Clayton said. “The criticism that these proposals will receive will say that we are not truly strengthening the standards applying to broker/dealers, and that the Form CRS is going to confuse more than help. These criticisms miss the point, and thanks to the work of our staff, we have taken a significant step to protect retail investors.”
Clayton also pointed out that the SEC is rolling out a “main street investor education campaign” to help investors learn the difference between advisers and brokers.
Important to note at this juncture is the fact that the rulemaking package is expansive, and it will take some time for experts to digest the changes made to the final rules and documents relative to the proposed version. At a high level, consensus seems to be building around the idea that the changes revealed today are not fundamental, and for that reason industry stakeholders have shared familiar comments about the final rulemaking package.
One expert pointed out that the SEC, under Chairman Clayton, has already seen three rules vacated/remanded back to the agency by a court. For this reason, the expectation on the part of some SEC watchers is that Reg BI will also face litigation.
As to how the new guidance will impact advisers to retirement plans, the Certified Financial Planner Board of Standards (CFP Board) issued statement saying, “Now that the SEC has issued its Regulation Best Interest rule and related guidance for investment advisers, consumers should know that nearly 85,000 CFP professionals will be obligated to provide financial standard.”
The CFP Board says the new rule complements its new Code of Ethics and Standards of Conduct that becomes effective on October 1, which “includes a duty of loyalty to place the clients’ interest above their own and their firm’s.”