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Regulation

SEC weighing complex investment advice package

Standards of conduct similar to now-quashed DOL fiduciary rule

Karen Barr called the package ‘one of the most complex rule-makings’ issued by the SEC.

The SEC is making a concerted effort to tackle one of its most complicated issues — a standards of conduct package covering investment advisory professionals.

"This is one of the most complex rule-makings that the SEC has had to address," said Karen Barr, president and CEO of the Investment Adviser Association in Washington. "It is multifaceted, there are a wide range of business models and types of investment advice, there's a wide range of marketing practices and there are a wide range of interests. So I think this is complicated both from a technical perspective and politically."

The Department of Labor's fiduciary rule was similar in scope, but the 5th U.S. Circuit Court of Appeals vacated it in March, saying it represented regulatory overreach. While the SEC does not focus exclusively on retirement plans, industry experts said the proposals nevertheless could affect them.

The proposals, approved by the commission in April and put out for a public comment period that closed Aug. 7, feature three legs:

A best-interest standard that compels brokers to put clients' financial interests ahead of their own and requires them to mitigate financial conflicts.

The client relationship summary, or Form CRS, which necessitates that firms disclose to retail investors the nature and scope of their services, the types of fees customers would incur, the conflicts of interest faced by the firm and the firm's disciplinary history.

A standard of conduct for investment advisers that states advisers have a duty to act and provide advice that is in the best interest of the client.

In testimony before the House Financial Services Committee last month, Dalia Blass, director of the SEC's division of investment management, estimated there were more than 6,000 comments on the rule-making package.

In its comment letter to the SEC, the American Retirement Association applauded the commission's decision that recommendations to rollover or transfer assets from retirement plans should be covered under the best-interest standard.

But since many participants do not roll over their retirement plan accounts until they reach retirement age, "it is paramount that financial professionals be held to a high standard of care when providing investment advice to (fiduciaries) responsible for retirement plan assets," the ARA wrote. It asked the SEC to clarify the standard to avoid any "gap" in regulatory coverage.

The National Association of Government Defined Contribution Administrators, Lexington, Ky., sought confirmation in its comment letter on whether participants in defined contribution plans are covered under the best-interest standard. While the proposal states that "the definition of 'retail customer'... would cover, for example, participants in ERISA-covered plans and IRAs," the SEC did not address whether DC plan participants, like public employees who are not covered by the Employee Retirement Income Security Act of 1974, would be considered retail customers, NAGDCA stated.

Several suggestions

The IAA in its comment letter outlined several suggestions it said would enhance the rules. Ms. Barr said the best-interest standard would be better suited if its scope was applied to all advice that broker-dealers give their clients. The proposal would require broker-dealers to give advice in the clients' best interest only when the broker is making a specific investment recommendation. The standard would not extend to the entire broker-client relationship, like it does for investment advisers.

Overall, IAA is pleased the SEC is moving forward on the issue, Ms. Barr said.

The same is true for the Securities Industry and Financial Markets Association. Kevin Carroll, SIFMA managing director and associate general counsel, said he's unsure why the proposal is controversial. "We just see this as raising the conduct standards for broker-dealers, which enhances investor protection."

Mr. Carroll said the best-interest standard recognizes the "inherit differences between broker-dealers and advisers and creates a standard that's specific to brokers and that's why I think this approach is going to work."

Jason Berkowitz, vice president and counsel for regulatory affairs for the Insured Retirement Institute in Washington, said the proposals represent a sensible approach. But one item the institute would like to see altered is the Form CRS proposal. According to Mr. Berkowitz, the proposal didn't take into account how variable annuities are "often sold through broker-dealers but are not in brokerage accounts. The contracts are actually held by the insurance companies."

"We're trying to help them fine-tune what we think is a very good proposal," he added.

Looking ahead

SEC Chairman Jay Clayton has devoted time and resources to the rule-making package this year, including hosting six roundtable discussions in June and July. In testimony before the House Financial Oversight Committee in June, Mr. Clayton said, "There are conflicts in an investment adviser relationship and there are conflicts in a broker-dealer relationship. Disclosing them, mitigating them making sure that everybody understands what the motivations are, that's what we're going to do in this space … or I should say that's what I want to do in this space."

David G. Tittsworth, a lawyer at Ropes & Gray and former president and CEO of the IAA, said he's not expecting any resolution on the matter this year.

"Could he possibly get a vote of the five commissioners before the end of this year? Yeah, I think it's possible," Mr. Tittsworth said. "That would be really aggressive. There's so many controversial issues wrapped up in the three (SEC proposals)."

It's more likely that something gets done in the first or second quarter next year, he said. But politics will come into play regardless of the timing. "I don't see a way that he could get a bipartisan vote, that he could get anything other than 3-2," Mr. Tittsworth said of Mr. Clayton. "I'm sure he would like to avoid a 3-2 vote but on that particular set of proposals I just don't see it ever happening. Whoever the five commissioners are I think that it will be 3-2."

With the Senate confirmation of Elad Roisman last month, the SEC once again has a full slate of commissioners, with Republicans holding a 3-2 majority.

One Republican commissioner, Hester Peirce, has criticized the Form CRS proposal. In a speech over the summer now posted on the SEC's website, she said: "Form CRS is chock-full of legalese and technical terms. Is this approach, which seeks to familiarize investors with terms they might encounter in their interactions with financial firms, appropriate?"

There will likely be changes made to the Form CRS proposal, Mr. Tittsworth said. "You've got to have (Ms. Peirce's) vote or there's no way you're going anywhere."