The Securities and Exchange Commission’s new best-interest standard for broker-dealers won’t take effect for almost another year but the transition could be very rough, and not just because of the “very aggressive implementation timeline” that SEC Commissioner Hester Peirce has warned about.
Already the House of Representatives has passed legislation to prevent implementation of the rule, but the Senate is not expected to follow suit. The differences between the two branches, however, may serve to highlight the controversies surrounding the rule.
In addition, “a number of industry groups are readying lawsuits against the SEC BI rule, which will likely gain some degree of traction,” said Brian Hamburger, founder and managing director of MarketCounsel, at a recent Pershing symposium for RIAs held in New York. He would not elaborate.
Marcia Wagner, founder of the Wagner Law Group, which specializes in ERISA and employee benefits law, says there is “a high likelihood that a civil action will be filed against Reg BI on the basis that the rule fails to comply with the intent of Dodd-Frank, if not the specific language of the Act, by not establishing the same standards for broker-dealers and investment advisors, or an inadequate economic analysis.“
Meanwhile, more states are expected to enact or introduce their own fiduciary rules, inspired in part by the failure of the SEC to do so in Reg BI. Those rules, too, are likely to be subject to lawsuits given the opposition already expressed by financial firms and industry groups to fiduciary rules that have already been proposed.
To date New Jersey, Nevada and Massachusetts have proposed fiduciary rules for broker-dealers, and legislators in Maryland, whose first attempt at a fiduciary rule failed earlier this year, and New York are considering their own state proposals.
Reg BI: Not Suitability Nor Fiduciary
The almost 800-page Reg BI essentially lowers the fiduciary standard that investment advisors are required to follow under the Investment Advisers Act of 1940 while raising the suitability standard, enforced by the Financial Industry Regulatory Authority, for broker-dealers, Hamburger said.
RIAs, for example, would not have to eliminate all conflicts of interest that would prevent them from acting in the best interests of their clients so long as they disclosed those conflicts.
But broker-dealers would be required to go beyond recommending investments that they deem suitable for clients and put their clients’ interests above their own, including the costs of their recommendations for their clients.
Broker-dealers would also need to disclose specific conflicts of interest when they arise, but not all potential conflicts need be eliminated. Contests that reward brokers for high-volume sales of individual products would be eliminated, but not contests that reward brokers for accumulated high-volume sales of multiple products, for example.
Reg BI “creates a best-interest standard that looks strangely similar to the suitability standard and alters the fiduciary definition of a financial advisor … bringing them closer together,” Hamburger said.
Adding to the confusion are the requirements for hybrid advisors who serve as fiduciaries and broker-dealers, sometimes for the same client, because the rules governing each are different.
While a broker-dealer would not be allowed to call herself an advisor, a hybrid advisor could do so for a specific client relationship so long as the advisor does not also serve as a broker for that client.
Brokers and advisors will be required to define their relationship to clients in a new Form CRS (Customer Relationship Summary) that provides information about services, fees and costs, conflicts of interest and the legal standard of conduct as well as the disclosure of any disciplinary history associated with the firm or advisor.
Before Reg BI takes effect, however, a new Code of Ethics and Standards of Conduct from the Certified Financial Planner Board of Standards is set to take effect on Oct. 1. The new code requires that all designated CFPs, including those who are brokers, act in the best interest of their clients at all times when providing advice as fiduciaries. Reg BI does not require brokers to operate as fiduciaries, which adds another layer of complexity to the regulation of brokers and advisors.
“Now that the SEC has issued its Regulation Best Interest rule and related guidance for investment advisers, consumers should know that nearly 85,000 CFP professionals will be obligated to provide financial advice under a fiduciary standard,” according to the CFP board statement, indicating it won’t back away from the requirement. It could, however, delay implementation.
Finally, the Labor Department expects to issue its own standard-of-conduct rule for advisors who work with retirement plans in December, according to testimony by Labor Secretary Alexander Acosta before a congressional panel on May 1, about a month before the SEC finalized Reg BI. Acosta said Labor was collaborating with the SEC on its upcoming rule.
The Labor Department’s previous fiduciary rule, developed during the Obama administration, was ultimately thrown out in federal appeals court in June 2018, and the Trump administration decided not to appeal that decision.
— Related on ThinkAdvisor:
- Will Reg BI Be Hammered by Lawsuits?
- Rep. Waters Seeks to Block SEC Regulation Best Interest
- Ron Rhoades: SEC Reg BI Is ‘Greatest Securities Fraud in History’
- SEC Reg BI Involves ‘Massive Implementation’ Process: Peirce
- More States Advance Their Own Fiduciary Rules
- SEC’s Reg BI Adds Unexpected Fiduciary Hurdle for Retirement Advisors