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SEC Comment Period Draws to a Close as DOL Guidance Expected

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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.

Jim and Joan were also participants in the Acme pension plan.

The advisor recommends that the pension benefits be withdrawn and rolled to IRAs. It appears that the withdrawal recommendation WOULD NOT be subject to the best interest standard (because it does not require that Jim and Joan buy, sell or hold any securities), but the recommendations about investing in the rollover IRA WOULD be.

The advisor helps Jim and Joan invest their accounts inside their new 401(k) plan. That WOULD be covered by Reg BI.

As the business becomes more successful, Jim and Joan set up personal accounts with the broker-dealer. Recommendations on those personal accounts WOULD be subject to the best interest standard. But, if they had an account for their business, those recommendations WOULD NOT be.

The business continues to grow and the advisor recommends that Jim and Joan set up a cash balance plan and assists them in the asset allocation and selection of investments for the plan. That WOULD NOT be subject to Reg BI.

With the continued success of the business, Joan and Jim decide to have children and the advisor helps them set up 529 accounts for their children’s education. The 529 investments WOULD BE subject to the best interest standard.

“Confused?” Reish asks rhetorically. “You should be.” The average investor, Reish argues, will be unable to decipher which rules apply to which situation. “The burden shouldn’t be on the investor to understand these technical rules,” he says.

Trump Nominates Kavanaugh, Issues Consumer Fraud Task Force Order

President Donald Trump in mid-July not only nominated a new Supreme Court Justice, Brett Kavanaugh — who sided with the Financial Planning Association a decade ago to derail the SEC’s “Merrill Lynch Rule” — but he also issued an executive order establishing a Task Force on Market Integrity and Consumer Fraud.

In issuing the order, Trump stated that the task force will help “strengthen the efforts of the Department of Justice and federal, state, local, and tribal agencies to investigate and prosecute crimes of fraud committed against the U.S. government or the American people, recover the proceeds of such crimes, and ensure just and effective punishment of those who perpetrate crimes of fraud.”

The executive order requires the attorney general to set up a Task Force on Market Integrity and Consumer Fraud within the DOJ. The task force also will be charged with collaborating with financial regulators and other agencies, including the SEC, DOJ, the Consumer Financial Protection Bureau and the Federal Trade Commission.

Acting Associate Attorney General Jesse Panuccio said during a mid-July media briefing at DOJ that the Trump administration task force will build on the task force set up “in the wake of the financial crisis” under the Obama administration, “which is now a decade passed and [which] focused on specific financial crimes and frauds.”

The new task force, Panuccio said, will continue that work but “is a broader effort looking at other areas of consumer fraud and market integrity, such as elder fraud and the growing problem of cybercrime.”

As to DC Appeals Court Judge Kavanaugh, he was among the three-judge panel on the U.S. Court of Appeals for the D.C. Circuit, which voted 2-1 in 2007 to grant the FPA a victory in its court battle against the SEC.

Kavanaugh and Judge Judith Rogers agreed with the FPA that “the SEC had overstepped by allowing brokers to charge fees — ‘special compensation’ — for advice, in violation of the Investment Advisers Act of 1940,” said Skip Schweiss, head of advisor advocacy and industry affairs for TD Ameritrade Institutional.

Washington Bureau Chief Melanie Waddell can be reached at [email protected].


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