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

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.”