Bullard’s Blistering Critique of House Fiduciary Plan Offers Way Forward

You don’t protect investors by simply restricting their choices, congresswoman says

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In a recent congressional hearing at the Subcommittee on Capital Markets, Committee on Financial Services, a Fiduciary Bill Discussion Draft (DD) offered by Rep. Ann Wagner, R-Mo., showcased the latest arguments against SEC fiduciary rulemaking.

The congresswoman’s central point was as clear as it was pungent: brokers’ clients would be greatly harmed if brokers were required to put their clients’ interests first. In contrast to this message, professor Mercer Bullard’s testimony analyzing the DD provided a strong critique of the bill.

The congresswoman’s DD would require that the SEC undertake additional cost-benefit analysis of any new rule, identify whether investors are being “harmed or disadvantaged” under the current suitability standard, “verify that any final rule would actually “reduce investor confusion,” and require “harmonization” of rules for investment advisors, in exchange for requiring brokers to meet the fiduciary standard.

Wagner introduced her DD legislation by saying the fiduciary standard was “one of the biggest issues facing retail investors today….” as the DOL and the SEC are “heading toward a separate and massive rulemaking that could fundamentally change how families and investors choose financial products and services.”

The SEC, the congresswoman continued, “claimed this proposal would better protect investors … (but) failed to provide any evidence to support such a claim… that retail customers were being harmed or disadvantaged” under the suitability standard.

To the contrary, according to Congresswoman Wagner, real investor harm will result if broker-dealers are required to put their clients first. “It is everyday Americans who will be harmed when federal agencies regulate without justification," she says, "the new dad looking to buy life insurance so he can sleep better at night, or the mom looking to set up an education account for her child, but gets turned away because she is told she is not sufficiently wealthy. Or the grandfather who has fewer choices when deciding how to pass on wealth to his grandchildren.”

To emphasize her point, Congresswoman Wagner underscored, “You don’t protect investors by simply restricting their choices.”    

Much of the reporting on this hearing focused on the DD’s provisions and its likely impact on SEC rulemaking. Fair enough. However, more attention should be given to Mercer Bullard, former assistant chief counsel in the SEC’s Division of Investment Management and current investor advocate and law school professor, who testified at the hearing and delivered a blistering critique. Bullard’s comments were simultaneous measured in tone while sharply critical in its legal analysis.

Highlights of his points include the following.

Cost-Benefit Analysis

While Bullard expresses support for cost-benefit analysis and the “generally appropriate aspirational standards for rulemaking” in the DD, he explained how the DD provision would “create redundancies and confusion” because SEC rulemaking was “subject to a panoply of cost benefit-benefit analysis requirements that already substantially and unnecessarily interfere with the process of efficient rulemaking.” Citing these requirements, Bullard further notes how they are redundant with the “arbitrary and capricious standard” under “Section 706 of the Administrative Procedures Act,” that constrains rulemaking as “demonstrated by the courts that have vacated SEC rules deemed to be arbitrary and capricious.”

Noting that critics are correct to state the SEC has failed at certain times in the past to meet current cost-benefit analysis requirements, Bullard questions that increasing cost-benefit requirements will be a fix, suggesting, instead, that this approach “is the equivalent of addressing a national deficiency in college students’ tests scores by raising the score needed to pass the test.” As such he concludes the purpose of the DD appears simply “to prevent rulemaking altogether.”  

As important, Bullard discusses the limitations inherent in cost-benefit analysis. The DD “reflects a popular but erroneous belief that an agency can exhaust every avenue of inquiry that might reasonably lead to a better understanding of a rule’s costs and benefits. In fact, regulatory action is invariably based on imperfect information (and relies on) the exercise of reasoned judgment in the known absence of information that theoretically could improve the regulatory decision-making process.”  

Bullard quotes former SEC Secretary Jack Katz, who testified to Congress about the limitations of cost-benefit analysis and concluded a regulator can “rarely” predict with certainty how the market will respond to a rule, “It is difficult to accurately quantify the cost of compliance or quantify the value of benefits before one know how the industry will achieve compliance.”  

SEC and DOL 'Coordination'

The DD calls for the SEC to “coordinate” rulemaking with other federal agencies to “minimize conflicts,” and this is presumed to refer to the DOL’s expected reproposal in coming months of a fiduciary rule. This expected DOL reproposal follows the September 2011 withdrawal of DOL’s first proposal, which Bullard said at the time had “fatal flaws” and he urged the DOL to withdraw it. This call for “coordination” has been repeated by industry critics over the past three years, and repeated without offering any apparent justification to overcome the legal burden implicit in the status quo: Congress established two separate statutory frameworks with two distinct policy purposes, and their respective standards of conduct have been different, as was intended by lawmakers.

As Bullard states: “Securities law and ERISA are different regulatory schemes because they should be different. The public interest in employee benefit plans is far greater than for securities investment in general. Investment regulation takes on greater importance in the context of retirement benefits, where losses resulting from misconduct have greater adverse individual and societal consequences than losses associated with securities investments generally.”

So what does the issue of “coordination” really concern? Either “the possibility that the DOL may impose more stringent standards” on BDs than are imposed by the SEC, or “it reflects a desire to require the DOL to defer to the SEC’s fiduciary rulemaking,” Bullard surmises.

Reduce Investor Confusion

The DD also calls for requiring the SEC to make a “formal finding” that rulemaking will reduce investor confusion. Or as Bullard deadpans, “The provision effectively requires that Americans “become smarter” about the different requirements of brokers and investment advisors “before they can receive the benefit of a fiduciary duty.” This view—that the regulatory problem is investors, as opposed to regulation itself—he says is, perhaps in gross understatement, simply “extraordinary.”

Harmonization

The final provision of the DD effectively requires the SEC to impose harmonizing regulations on investment advisors if it seeks to impose a uniform fiduciary standard on brokers. Noting correctly that despite industry claims to the contrary, “There is no necessary connection between fiduciary rulemaking and rulemaking for advisers,” Bullard adds this provision is “Nothing more than rent seeking by an industry that wishes to regulate their clients’ competitors into submission,” and, taken in its entirety, the DD’s purpose is nothing more than to “promote the interests of one industry over another.”

Calling a Spade a Spade

In very different ways both Professor Bullard and Congresswoman Wagner have added to the discussion.

Wagner’s impassioned plea to spare brokers’ clients the harms of the fiduciary standard is important. It sets a course for a new conversation between the two sides that could be fruitful.  

Bullard’s sharp criticism of the DD is noteworthy, not because he is an investor advocate who might be expected to oppose these provisions. It is noteworthy because Bullard takes a moderate tack that reflects his wide-ranging experience and expertise and his openly independent views of the SEC and DOL. As examples, Bullard sharply criticized the first DOL proposed rule and agrees the SEC has failed to provide sufficient cost-benefit analysis in certain circumstances.

In this spirit, Bullard supports “smart cost-benefit analysis” that recognizes its limitations, and he explains the legal and policy differences at the core of what makes ERISA and securities laws unique, differences which, of course, he hints that Congress could address. In short, in a Washington world of uncompromising positions and politicized speech, Bullard’s major contribution may be simply identifying common ground while calling a spade a spade.    

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