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Regulation and Compliance > Federal Regulation > SEC

Ron Rhoades: SEC Reg BI Is 'Greatest Securities Fraud in History'

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The Securities and Exchange Commission has committed “the greatest securities fraud in history” by adopting Regulation Best Interest, making BDs “pretend fiduciaries” who think their duty of care can be satisfied by disclosing conflicts of interest, a belief that’s “ludicrous,” fiduciary law expert Ron Rhoades tells ThinkAdvisor in an interview.

The former estate planning attorney argues further that Reg BI “muddies” the difference between investment advisors and BDs by holding both to essentially the same standard: disclosing conflicts of interest. Rhoades is assistant finance professor and director of the financial planning program at Western Kentucky University.

He forecasts a gloomy scenario: Reg BI will result in consumers trusting advisors who aren’t held to a “bona fide” fiduciary duty to act in their best interest, then feel betrayed when they fail to do so, whereupon they’ll pull their money from the market and stop investing altogether. That withdrawal of capital will, in turn, slow U.S. economic growth.

Right now, legal challenges to Reg BI are looming, plus “a battleground” is brewing over what Rhoades calls “group boycotts” that BDs are threatening in view of Nevada’s proposed fiduciary rule and, separately, the Certified Financial Planner Board of Standards’ new rules focused on fiduciary, effective this October.

A frequent industry speaker and a consultant to the Garrett Planning Network, Rhoades, who for 10 years was chief operating officer of an investment advisory he co-founded, provides financial planning to a select group of clients.

ThinkAdvisor recently interviewed the RIA, on the phone from his office in Bowling Green, Kentucky. About Reg BI, he cautions: “If you’re an advisor [adhering to] the true fiduciary duty of loyalty, it’s going to be harder to distinguish yourself from those saying the same thing but who are not living up to the high standard of conduct you’re living up to.”

Here are highlights from our conversation:

THINKADVISOR: What’s your reaction to the adoption of Reg BI?

RON RHOADES: The SEC has made investment advisors and broker-dealers the same with basically the same standard: Disclose conflicts of interest. There are some small differences between them, but the major ones disappeared.

What are the implications?

The harm is that this regulation will convey to consumers that they can trust their broker and investment advisor [to act in their best interest] when that duty of loyalty isn’t there [for BDs]. The harm is going to far outweigh the benefits of increased disclosures by brokers. And of course, we know that disclosures generally are ineffective because consumers don’t read them — and even when they do, they don’t understand them.

You’ve tweeted that by passing Reg BI, “the SEC just committed the greatest securities fraud in history…” Why is it fraud?

The SEC has taken fiduciary duty and, in most cases, made it just a disclosure of conflict. [Heretofore] “best interest” has been used to connote the fiduciary duty of loyalty. But now, brokers have begun advertising that they act in the best interest of their customers, who are going to believe that means they represent the customer, when in fact that’s not the case.

You’ve also written that Reg BI will negatively affect economic growth.  How so?

There’s no question about it. It’s going to lead people to flee the capital markets altogether because their trust will be betrayed. Once trust in a[n] [FA] is betrayed, investors don’t want to participate in stocks or mutual funds or even bonds. They want to stick their money in a bank and are likely to not invest again. So between that and the higher fees and costs they’ll have to pay, it’s going to be a drag on our economy.


When fees and costs get really high, the grease that the financial industry is supposed to be for the economy becomes a sludge and slows it down.

You’ve just referred to the increased disclosures stipulated in Reg BI as “benefits.” Please elaborate.

It brings forth the duty to disclose conflicts of interest, though it’s unclear how that disclosure will be made and how robust it will be.

How do you think consumers will actually interpret “best interest”?

That “best interest” means best interest. The SEC has tried to redefine the English language, and they’re going to be called to task for it, hopefully by a court. I think the SEC abused its discretion and went beyond the legislative construct that was put in place by Congress many decades ago.

How will the SEC be rebuked?

I believe there will be a judicial challenge to Regulation Best Interest. Consumer groups are looking at it now. But the outcomes of these sorts of legal challenges are always uncertain, as we saw with the DOL [fiduciary rule].

What are your thoughts about the states proposing their own rules, as is the intention of New Jersey, Massachusetts and Nevada?

I’m for the states stepping in to protect their own consumers, even though that might lead to [several] different standards. But it’s pretty easy to comply: Just choose the highest standard and comply with that one. It’s likely that New Jersey will go forward. I think Massachusetts has a lot of strong support. Nevada will take their time.

What will obstructions to these state rules be?

Legal challenges. But again, it’s a big question mark anytime something goes through the courts.

What issues have surfaced about state rules thus far?

Several broker-dealer firms [including reportedly Morgan Stanley] have told Nevada that if it goes through with its rule, they’ll cease doing business in Nevada or curtail their sales activities there.

Any other challenge regarding the issue of fiduciary?

The CFP Board has been told by one broker-dealer, who says that, in accord with their trade association and other broker-dealers, they may not allow their brokers to remain certified financial planners should the Board proceed to implement its new standard of conduct as of Oct. 1. It basically applies a true fiduciary standard.

What are the legal implications to these threats?

It’s anticompetitive behavior and illegal. These actions are basically group boycotts. There’s pretty good case law that if you’re making threats in order to maintain your pricing power — which is the case here because [the firms are] trying to maintain their ability to charge a high cost for products and get more compensation for it — that’s unfair and is a deceptive trade practice [under] the Sherman Antitrust Act and the Federal Trade Commission Act.

What does this mean to the industry?

It’s potentially a whole other battleground where broker-dealers and their trade associations are engaging in anticompetitive practices by banding together and boycotting either the states or the CFP Board.

You’re a finance professor and also an RIA serving a select number of clients. How does REG BI affect your practice?

It hurts me because it muddies the water. It makes it harder for me to distinguish myself as a true, what I call, bona fide fiduciary from those who say they’re fiduciaries acting in the best interest of their clients [per Reg BI], or what I call a pretend fiduciary.

But the SEC says that Reg BI “… enhances the broker-dealer standard of conduct beyond existing suitability obligations, and aligns the standard of conduct with retail customers’ reasonable expectations by requiring broker-dealers … to act in the best interest of the retail customer … without placing the financial or other interest of the broker-dealer ahead of the interest of the retail customer …” Is that true?

No. It says that, but there’s a safe harbor [provision], which basically defines the exceptions to best interest. You could still say you act in the best interest if you make disclosures of conflicts of interest. Broker-dealers have said the duty of care that they have can be satisfied through disclosure, which is ludicrous. There’s a lot of vagueness that needs to be [clarified]. A lot has to be interpreted.


But who’s doing the interpretation? It’s the SEC. And who runs the SEC? A revolving door of Wall Street [people] and the SEC itself, both on the commission level and on the key policymaking staff. They have very close ties to the industry. So I’m afraid that though a lot of people say we’re going to be able to fix [the Reg BI fiduciary issue] when we get a Democratic administration, I’m not so sure that’s going to happen.

How will Reg BI affect wirehouse FAs?

There will be new disclosures that have to be made, including disclosures of specific conflicts of interest when they arise. There’s a new duty of care that you have to consider the features of products, benefits, cost. So there will be an increased cost-benefit analysis. But my guess is that [Reg BI] won’t very much affect [wirehouse brokers] — based on the current regulatory environment. Individual brokers and dual registrants are viewing this as another burden even though it’s additional paperwork more than anything.

How does Reg BI address revenue sharing, including 12b-1 fees?

Part of the litigation to emerge may be challenging 12b-1 fees, which, in my view, have always been advisor fees in drag, especially [on mutual fund] Class C shares, where brokers get paid 1% a year. I consider that special compensation. A broker isn’t allowed to [receive] special compensation without being subject to the fiduciary standard of the [Investment] Advisers Act [of 1940].

Now that Reg BI has been adopted, what do you think FINRA is going to do?

Probably either rescind its suitability rule [for brokers] because now a federal rule applies, or they’ll modify it to conform to what Regulation Best Interest does.

What feedback, if any, have you had about the rule from brokers?

I had an exchange with a broker in the past few days, in which he said; “Hey, I act in the best interest of my client: I sell variable annuities, equity-indexed annuities and whole life insurance.” [I thought], “Oh, my gosh!”

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