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July 30, 2018 at 04:00 PM
While the deadline for comments on the Securities and Exchange Commission’s advice standards package expires on Aug. 7, industry watchers await further compliance guidance from the Department of Labor on its fiduciary rule, which was vacated on June 21 by the U.S. Court of Appeals for the Fifth Circuit.
The “nature and timing” of Labor’s forthcoming guidance is uncertain, George Michael Gerstein, co-chair of Stradley Ronon’s Fiduciary Governance Group, told IA at press time in mid-July.
As to state fiduciary actions, Gerstein said to look for additional state legislation governing retail investment advice to be introduced early in 2019, with states to watch being New York and California.
During a House panel oversight hearing in late June, SEC Chairman Jay Clayton was peppered with questions about the agency’s proposed Regulation Best Interest for brokers. Clayton told lawmakers that a lengthier comment period on the commission’s advice standards proposals may be needed.
The SEC’s Regulation Best Interest, or Reg BI, “can be improved,” former SEC Commissioner Luis Aguilar told IA in mid-July, with “much of the issues [in Reg BI] stem[ming] from the lack of clarity,” namely in that “best interest” is not defined.
“What does [best interest] mean?” Aguilar continued. “Because the [proposed] rule was prompted by a desire of many to have brokers that act like investment advisors be put on the same level playing field as investment advisors, it’s puzzling that there is no mention [in Reg BI] of the fiduciary standard,” the standard “that has long applied” to advisors.
Rulemaking, Aguilar added, “can be a complex process, and perhaps the Commission was unsure what to do and is waiting for public guidance.”
Drilling Down on Reg BI
Fred Reish, partner at Drinker Biddle & Reath, has been drilling down on the SEC’s advice standards package in his “Interesting Angles” LinkedIn posts. His most recent entry in mid-July picks apart Reg BI’s practical impact on broker-dealers and advisors. What does he find?
Given the definition of “retail customer” in Reg BI as currently proposed, the duties owed by the advisor and the broker-dealer “bounce around,” Reish states.
Based on conversations he’s had with securities lawyers, Reish writes that the definition of “retail customers” appears to refer to individuals, participants’ accounts in retirement plans, IRAs, custodianships, guardianships and personal trusts.
“That’s not meant to be an exhaustive list, but it is meant to point out that it doesn’t appear to apply to business accounts or retirement plans,” Reish explains. “I’m surprised that [Reg BI] doesn’t apply, at the very least, to small businesses and small plans.”
He offered these examples of how the duties owed by advisors and brokers under Reg BI would become confusing.
Assume that Jim and Joan Smith, a married couple, have been working for a large company, Acme Corporation. However, they decide to leave Acme and to start up “Jim and Joan’s Bakery.”
Fortunately, the bakery is successful and their cash flow is strong enough to start a retirement plan for the two of them, the only workers at the bakery. Knowing that the company will grow, their advisor (who works for a broker-dealer) recommends that they set up a 401(k) plan and recommends the investments.
Those recommendations would NOT be covered by the Reg BI best interest standard of care.
At the same time, though, the advisor recommends that Jim and Joan take distributions from the Acme 401(k) plan and roll that money into IRAs. Both the rollover recommendation and the recommended IRA investments WOULD be covered by the best interest standard.
