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Regulation and Compliance > Federal Regulation > SEC

Defining ‘Best Interest’ Standard in Fiduciary Debate a Head Scratcher

By Melanie Waddell

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Two industry trade groups and the Financial Industry Regulatory Authority came out recently with uniform best interest standards in an attempt to squelch what they say will be competing fiduciary plans to be issued by the Department of Labor and the Securities and Exchange Commission.

The Obama administration-backed DOL plan, which seeks to revamp the definition of fiduciary under the Employee Retirement Income Security Act, is out for a public comment period until July 21, with the department planning to also hold an August hearing on the proposal. The department anticipates a total of 140 days for public comments.

Administration officials have vowed that after comments are weighed, the plan will be approved in some form, despite legislative efforts to make DOL wait to issue its plan until the SEC acts on its own uniform fiduciary rulemaking.

Steve Saxon, chairman of Groom Law Group, said at the recent SPARK conference in Washington that DOL will push to issue a final rule by May 2016 so that it can have a rule in place before Jan. 20, 2017, the day the new administration takes office. If the DOL’s redraft is still “outstanding” by Inauguration Day, and a Republican candidate wins, that would present problems for the Obama administration-backed rule, Saxon said.

But a House Appropriations bill is threatening to nix funding for DOL’s fiduciary rulemaking. (See “Familiar Face Returns to SEC as Two Commissioners Plan Exit.”)

SEC Chairwoman Mary Jo White has said the agency is forging ahead in crafting its own fiduciary rulemaking under Section 913 of the Dodd-Frank Act, but that such a rulemaking is “just getting started.” However, industry officials are still trying to figure out exactly what the term “best interest” of the client standard means.

In introducing the Securities Industry and Financial Market Association’s best interest plan, Ken Bentsen, SIFMA’s president and CEO, said that such a standard would offer a “solution that works,” reflect what regulators have “been migrating toward” and avoid the current atmosphere where the SEC and DOL “are headed down separate and inconsistent paths” with their fiduciary plans.

SIFMA said its best interest standard “could be articulated, for example, through amendments” to existing FINRA rules, “as approved by the SEC,” and in a way that would be consistent “not only with SIFMA’s historical position” and with Dodd-Frank Act’s Section 913, but also with the “best interest standard set forth in the DOL’s [best interest contract exemption], and without certain conditions and requirements currently contained” in that exemption.

Bentsen said that SIFMA’s plan would apply across “all investment recommendations made to individual retail customers in all brokerage accounts, not just IRAs or other tax-deferred accounts.”

It would also:

  1. Serve as a benchmark for, be consistent with and integrate seamlessly into the SEC fiduciary standard that ultimately emerges under Dodd-Frank Section 913.

  2. Provide substantive best interest protections for retail customers in the interim.

  3. Follow the traditional securities regulatory approach of establishing a rules-based heightened standard, including a robust disclosure combined with examination, oversight and enforcement by the SEC, FINRA and state securities regulators, and a private right of action for investors as exists today.

The Financial Services Roundtable proposed its own best interest standard, which creates a new prohibited transaction exemption (PTE) based on the investment advice exemption already allowed under the 2006 Pension Protection Act, which amended ERISA.

A rule based on the PPA exemption, FSR said, “would still require that financial professionals and firms act in the best interest of each customer and provide appropriate disclosures without such significant disruption to customers,” as it says the DOL rule would require.

DOL’s proposed rule, FSR said, “would substantially alter […] existing PTEs and many business models, and therefore impact millions of retirement savers.”

The FSR alternative “would recognize that the fees and expenses of various investment products and services vary based on the type of product or service; thus, commissions or fees would be uniform among the same class of investment alternatives.”

FINRA Wants SEC to ‘Take the Lead’

FINRA CEO Richard Ketchum has publicly voiced his opposition to the DOL plan, saying the SEC should “take the lead” in crafting a best interest standard that covers all types of products.

However, Dennis Kelleher, president and CEO of Better Markets, told Ketchum in a recent letter that his opposition to DOL’s rule is “ill-informed,” and that the DOL, not the SEC, “has longstanding Congressionally mandated authority to set standards for those providing investment advice about retirement assets.”

Ketchum has offered his own alternative approach to move forward a “best interest of the customer” standard. He said in late May that “it is time for us to reach agreement on a best interest solution that embraces three essential tenets: active identification and management of firms’ conflicts; dramatically improved disclosure of risks associated with the product and product-related fees, and firm and third-party incentives; and more effective management of the compensation incentives to registered persons.”

He advocated once again for requiring broker-dealers to provide customers a Form ADV-like document annually that uses clear, plain-English descriptions of the conflicts they may have and an explanation of all product and administrative fees.

What Exactly Is the ‘Best Interest’ Standard?

Knut Rostad, president of the Institute for the Fiduciary Standard, noted that while SIFMA’s plan is a reminder that the “best interest” standard is important, such a standard “needs to be affirmed in federal regulations today as the authors of the Advisers Act intended.”

The term “best interest,” Rostad argued, “is often used, it seems, as though there is a clear cut ‘best interest’ standard in federal regulation.” Rostad said, “This is not true, in large part because there is no agreement that common law and ‘original’ views of the Advisers Act of 1940 should prevail. So, the standard remains ill-defined in federal regulation.”

The differing views of the DOL and SEC, he continued, “are stark.”

Rostad also argued that while SIFMA’s best interest plan “woefully understates why conflicts of interest are so important to avoid,” SIFMA does offer new views on fees. “Kudos to SIFMA for discussing the importance of reasonable fees.”

Don Trone, founder of 3ethos, said that defining what best interest of the client means depends on the “practices associated with the standard. Labels and titles mean little until you define the details of the practices that constitute the standard.”

What’s being—or will be—proposed by the various groups now, Trone said, are “different gradations of ‘best interest,’” including an ERISA standard, an SEC standard, a FINRA securities standard and a common law standard.

The “SEC has never defined the specific practices that constitute their fiduciary standard, relying instead on the industry to define the practices,” Trone said.

As for a securities standard, the question is “what practices are associated with a securities standard?” Trone continued. “They’ve never been listed, and until they are, we have no way of knowing how the securities standard stacks up to ERISA or SEC.”

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