Phyllis Borzi, Labor Department assistant secretary for the Employee Benefits Security Administration (EBSA) from 2009 to 2017 and key architect of the department’s now-defunct fiduciary rule for advising retirement accounts, spares no disdain for the Securities and Exchange Commission’s proposed Regulation Best Interest.
In an interview with ThinkAdvisor, she dismisses Reg BI’s use of “best interest” as “a marketing slogan” and the proposed rule “not even as strong as [the] suitability [standard].” She is especially critical of Regulation Best Interest because it allows financial advisors to not work in the client’s best interest as long as they disclose the conflict.
(Related: Borzi: DOL Should Not Defer to SEC’s Reg BI)
In government and academic posts, Borzi forged a career of fighting for consumers. Now she’s doing it from inside the financial services industry as a member of Edelman Financial Engines’ board of directors, as of last November. This marks the first time the attorney and former university professor has served on a corporate board.
Borzi continues to advocate strongly for the fiduciary standard of care because, she argues, brokers are “trapped in a compensation system” requiring them to adhere to a loyalty duty not to their clients but to their firm or to product manufacturers.
But, she insists, neither can investors “rely on the government to protect [their] interest” when seeking investment recommendations. Accordingly, they must try to protect themselves by hiring an advisor who not only says they’re a fiduciary but who’ll commit that to writing.
The Labor rule was designed to prevent broker conflicts of interest in retirement accounts. Borzi guided it through the system for more than six years. In June 2018, following a series of court battles, the rule was vacated by the U.S. Court of Appeals for the 5th Circuit.
Two months earlier, the SEC had proposed its own best-interest regulation for a standard of care for BDs and advisors covering all investment recommendations, not just those for retirement accounts. The commission is expected to release its final rule by September.
Prior to her post in the administration of President Barack Obama, overseeing administration, regulation and enforcement of Title 1 of the Employee Retirement Income Security Act of 1974 (ERISA), Borzi was a research professor in the department of health policy at George Washington University. She was also of counsel with the law firm O’Donoghue & O’Donoghue, specializing in ERISA and other legal issues concerning employee benefit plans.
ThinkAdvisor recently interviewed Borzi, speaking from her Maryland office, where she was preparing to serve as an expert witness in a handful of pension and health plan cases concerning possible breach of fiduciary duty. Our conversation included her relating a tense encounter with an incensed financial advisor who insisted that he always acted in his clients’ best interest. After he told her what his due diligence entailed, she explained that he was not in fact acting in his clients’ best interest. But his anger beclouded Borzi’s logic.
Here are highlights of the interview:
THINKADVISOR: You’ve joined Edelman Financial Engines’ board of directors. So, are you part of the financial services industry now?
PHYLLIS BORZI: That’s an interesting question. I never thought about it that way. I guess I am. But, hopefully, I’m in the part of the industry that’s trying to align the financial interest of people providing advice with the end users of the products. Any issues — like strategic objectives and new products — that the firm will put before the board for advice, I’m going to look at from a consumer point of view.
This appointment is a departure for you. Your background has been in government, academia and law.
It’s the first time I’ve ever been on a corporate board. It makes sense that I’m on this one because these two merged companies were both early supporters of the [Labor Department’s] conflict-of-interest rule. The [merged firm] holds itself and its advisors to fiduciary duty even though they’re not legally required to do so. Their product, if you will, is fiduciary advice, in which the duty of loyalty the advisor has is to the client, not to anybody else.
Are financial advisors, in general, responsible for conflicts of interest, where they exist?
I certainly don’t think brokers are bad people. They’re people who are trapped in a compensation system that rewards them for having a duty of loyalty to someone other than their client. That duty is to the company they work for, the manufacturer of the product they sell. Many brokers bristle at the idea that they’re not working in the client’s best interest. They genuinely believe that what they’re recommending is in their clients’ best interest. That may or may not be so.
What’s an example of such a broker?
In a speech I made to consumers early in the process [of establishing Labor's fiduciary rule], I said it was the compensation system that encouraged brokers to sell certain products [over] others. From the stage, I saw a guy in the audience who had such hostility on his face that if looks could kill, I’d be dead.
The second I finished my speech, he charged up on the stage. I thought he was going to smack me. He was really irate: “How dare you suggest I don’t care about my clients!” he said. One of the principles I laid out was: Don’t buy products you don’t fully understand, and that you shouldn’t assume that your advisor understands them.
The broker was mad about that, in particular?
He was shaking his finger and yelling at me: “I never sell any product to my clients that I don’t fully understand!” And he said that to keep up with it all, he goes to two [of a certain big] company’s seminars for its highest selling brokers a year — one in Hawaii, one in Arizona — taking along his wife and family for free. For five days, the [firm] talks about all the new products they have — their own products only.
How did you respond to that?
I said: “You recommend only products that you understand, and that’s a good principle. However, the due diligence you do consists of going to two all-expense-paid seminars, for which you have to qualify by selling a lot of that company’s products. So it feeds on itself.” I gently suggested that there was a problem, but he was too angry to see it. This isn’t uncommon. I do believe with all my heart that this guy absolutely thought he was acting in the client’s best interest.
What are your thoughts about the SEC’s proposed best-interest regulation?
Initially, I was encouraged, even though I knew the [SEC] wasn’t going to be as strongly pro-investor as we were at the Department of Labor. Its statute flatly bans conflict of interest, whereas the securities’ laws generally permit conflicts of interest if they’re adequately disclosed, and in some cases, mitigated.
You were “encouraged” initially. Then what?
When I saw the proposals, I was disappointed because they had very obvious big flaws. I was hopeful, though, that maybe through the public comment process, they would improve the rule.
Was that the case?
When I saw the comments, it was obvious that the proposals were by and large the industry’s own proposals — and of course they had suggestions to dilute the rule [too]. I didn’t see much deviation in the proposals from what the industry had been trying to get [the DOL] to adopt for six-plus years.
What do you see as Reg BI’s big flaws?
The problem that we [the Labor Department] wanted to solve was unchecked conflict of interest that harmed investors. The SEC documents said the problem is investor confusion. But confusion is a symptom of harm that’s being caused by unchecked conflicts of interest. It’s not a problem in and of itself. The confusion is in the marketplace because everybody claims to be a trusted advisor when some are really only salespeople. There’s no confusion in the minds of investors as to what they want. They’re very clear.
What do they want?
They want somebody they trust who makes recommendations that put their interest first and don’t allow the advisor to profit financially at their expense.
What’s the solution?
If you make recommendations, you need to stand behind them. The standard of conduct that applies [is] fiduciary. That’s the simplest, most effective way of making sure that consumers aren’t confused.
But Reg BI calls for advisors to say they’re working in the client’s best interest.
The problem with that phraseology is that “best interest” is used as a marketing slogan. It doesn’t necessarily mean it’s a legally enforceable standard of care. It just says you have to work in your client’s best interest. It doesn’t define what that is. Worse, [Reg BI] creates a safe harbor that allows [advisors] to not work in their client’s best interest as long as they disclose their conflict. That isn’t even as strong as [the] suitability [standard].
What can be done to correct all that?
One way they could fix the problem is to create a definition of “best interest.” And clearly, they have to get rid of that safe harbor because it allows [advisors] to not act in their client’s best interest as long as they disclose [their conflict].
How likely is it that the SEC would make those changes? Highly unlikely. The industry basically has endorsed what the SEC is doing [though] they’d like to weaken it even more. [Mostly] they all encourage the SEC rule to move forward with it largely unchanged. But, you know, I never give up hope.
Is there anything the DOL can do?
The SEC is much more industry-friendly than the Department of Labor was in previous administrations. The [Trump] administration reversed virtually everything the Obama administration did. I would guess that the current leadership in the Department of Labor is a lot more industry-friendly than we were, for sure.
What’s your position on the states establishing their own fiduciary rules, such as what Nevada and New Jersey are trying to do?
That would not be my first choice. I’m a strong believer in uniform federal standards as better for investors and the industry — one set of rules that apply across the board. But to get to that point, you need both the SEC and the Department of Labor to be equal partners.
What else complicates the issue?
The industry is always whining about one size-fits-all rules. It’s constantly saying that the SEC is the premier regulator. Well, it’s not. It depends on what you’re trying to do. We were trying to deal with retirement issues and advice that retirement investors get. The SEC isn’t the primary and only knowledgeable regulator [for that].
What went through your mind when the appeals court nullified the DOL fiduciary rule?
I was disappointed but not surprised. When we learned the names of the panel of judges that were going to hear the case, we knew from their record that they were unlikely to support what the Department of Labor had done. But we were hopeful.
Clearly, you weren’t happy with the decision.
I wasn’t there, but I’m told that Judge Edith Jones was openly hostile toward the government. Her opinion was surprising in the sense that it disregarded a lot of the precedent under ERISA, and I don’t think her opinion was particularly well-reasoned. Also, it didn’t surprise me at all that the Trump administration decided not to challenge it. They were trying to kill [the rule] anyhow.
So now, is the onus on investors to protect themselves?
No. I don’t think so. But you can’t rely on the government to protect your interest in all these [investing] situations. So you need to take some initiative. You can try to help yourself, especially in the selection of an investment advisor. You can get somebody who’s willing to act as a fiduciary and willing to put that commitment in writing. That’s an important way to ensure fiduciary liability.
I assume that you’re quite familiar with FINRA arbitrations as they pertain to fiduciary duty?
Many years ago, I went to the FINRA website and read the enforcement press releases. That was an eye-opener. The most important thing [investors] have to do in these cases is establish that the person who gave them the advice on which they relied is a fiduciary — because that’s what they fight the hardest.
In all the [investor] complaints I saw filed with FINRA against individual brokers, [the advisors] argued: “We’re not fiduciaries. We just sell product.” Well, that’s’ pretty telling. They all argue, “We don’t owe a duty of loyalty to our customers.” Oh, really! Do you think the customers knew that! What investor is going to hand over their assets to someone who claims they don’t have a duty to them? It’s just ludicrous!
What’s paramount for investors to keep in mind when hiring a financial advisor?
I’m saying this as Phyllis Borzi, taxpayer, not in any official capacity: It’s finding someone you can trust who is willing to express in writing the fact that they have a duty to you and that that duty to you is primary. Getting it in writing will help even without any regulation [if] you get to a FINRA suit.
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