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The word compliance with related words drawn on a sheet of paper

Regulation and Compliance > Federal Regulation > SEC

New FSI Report Takes On 'Regulation by Enforcement'

By Melanie Waddell

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The Financial Services Institute released steps the Securities and Exchange Commission should take to end what FSI claims is the agency’s long-held practice of regulation by enforcement.

In a new white paper released Tuesday, FSI defines regulation by enforcement as “when an enforcement action involves certain conduct that market participants did not previously understand to be a violation of the federal securities laws despite these market participants’ reasonable efforts to interpret existing laws, regulations, policies, and guidance from the SEC and other agencies.”

FSI, a trade group for independent financial advisors and the firms they affiliate with, has seen the SEC’s crackdown on 12b-1 fees via its Share Class Selection Disclosure Initiative as “backdoor regulation,” or regulation by enforcement.

The securities regulator, according to FSI’s paper, “should adopt a procedural framework, through concrete procedures, to detect and prevent certain unfair enforcement practices by the commission and its staff.”

The paper provides “common-sense solutions that will assist the SEC in detecting and preventing regulation by enforcement, and we welcome opportunities to collaborate with the SEC” to curtail the practice, Dale Brown, FSI’s president and CEO, said Tuesday in a statement announcing the paper.

FSI ”members have experienced the harmful effects of regulation by enforcement first-hand,” Brown said. “We share the Commission’s investor protection goals, and we strongly support regulations adopted through the proper rulemaking process. However, regulation by enforcement hinders independent financial services firms’ and financial advisors’ ability to properly serve their clients and confidently operate their businesses.”

Regulation by enforcement, according to the report, includes “the circumvention of agency rulemaking requirements, violation of the rights of the regulated by not allowing the opportunity for notice and comment, and the undermining of the agency’s authority by generating a perception of unfairness.”

Reg BI

The paper, authored by attorneys Peter Chan and Valerie Mirko, on behalf of FSI, states that while the SEC took the appropriate rulemaking steps with Regulation Best Interest, any attempts to extend the rule ”that were not contemplated during rulemaking and guidance drafting” should be avoided.

While Reg BI “has been subject to several statements and FAQs, these refine questions that were partially addressed in rulemaking and require further clarification, as opposed to attempting to address new areas or new obligations beyond the [rule's] four core obligations,” the report states.

Reg BI “also underwent a full rulemaking instead of the SEC attempting to evolve the standard of care for broker-dealers through application of a theory of negligent fraud to the then-existing suitability standard,” the report continues.

There remains the potential for the SEC — whether the staff or the commission — to further define “certain contours of Reg BI beyond the standard available through rulemaking and follow-up issuance of guidance, as well as through settlement orders, particularly with regard to applying the Reg BI standard to individual registered representatives,” the report says.

It’s ”imperative that Reg BI continues to be applied pursuant to the rule text and guidance and not extended in ways that were not contemplated during rulemaking and guidance drafting,” the report states. ”In turn, new rule proposals addressing conflicts of interest should not be overly lengthy and should be additive rather than duplicative.”

FSI stated in separate comments to ThinkAdvisor that “not all enforcement action — on Reg BI or other regulations — is regulation by enforcement.”

Melanie Waddell

@Think_MelanieW

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