Industry, regulators prepare for shakeout from conduct package
The Securities and Exchanges Commission has made its standards-of-conduct package proposal a top priority, with a final rule expected in the coming months.
Depending how things shake out, there could be residual implications for a number of industry stakeholders, including fellow regulators and state officials.
Late last month, Robert Colby, chief legal officer at the Financial Industry Regulatory Authority, said the organization will re-examine its suitability rule for broker-dealers, once the SEC issues its package, which has become commonly known as Reg BI. The suitability rule has similar goals and requires, in part, that a broker-dealer or associated person has "a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer."
Reg BI, in part, aims to require broker-dealers to put clients' financial interests ahead of their own and mitigate financial conflicts.
"There's a lot of overlap between the existing suitability rule and the direction that Reg BI's going in order to mitigate conflicts," Mr. Colby said during a panel discussion at the Securities Industry and Financial Markets Association's annual compliance seminar in Phoenix, adding that FINRA could tweak its rule, if necessary. "If we do keep it, we want to make sure that they're completely aligned," he said.
Phyllis Borzi, who served as assistant secretary of labor for the Employee Benefits Security Administration from July 2009 to January 2017, said it would be a bad idea for FINRA to scrap its suitability rule because Reg BI doesn't go as far.
When examining both rules, David G. Tittsworth, a lawyer at Ropes & Gray LLP in Washington, said Reg BI establishes higher standards for broker-dealers because it requires them to disclose and in some cases mitigate conflicts of interest. Critics say Reg BI's current disclosure requirements are insufficient because broker-dealers would be able to disclose potential conflicts and go about giving advice all the same.
At the Department of Labor, the 5th U.S. Circuit Court of Appeals vacated its fiduciary rule in March 2018, saying it represented regula- tory overreach. But in its fall regulatory agenda, the DOL said it is "considering regulatory options in light of the (5th) circuit opinion," with a final rule expected by September.
Michael P. Kreps, Washington-based principal at Groom Law Group, said it's likely staffers at the DOL and SEC have communicated during this rule-making process, and in a 2017 Wall Street Journal op-ed, Labor Secretary Alexander Acosta wrote about the importance of working with the SEC on this issue.
"I don't anticipate the Department of Labor moving in the short term to do much, although they may, but you'd expect longer term that they would at the very least begin to harmonize with the SEC and make sure that anything the SEC does is workable from an ERISA perspective," Mr. Kreps said.
If Reg BI were to make certain financial professionals operate as fiduciaries, they could be subject to the DOL's prohibited transaction rules, which generally means those professionals can't give advice that results in them receiving additional compensation without an exemption, Mr. Kreps noted. The DOL may then issue a rule of its own or make certain clarifications in response, he added.
Groups such as the National Association of Government Defined Contribution Administrators and SIFMA are concerned that the proposal as written could improperly impact DC plan participants and institutional investors, respectively.
SIFMA has urged the SEC to limit the scope of its best interest standard for broker-dealers to retail investors. Kevin Carroll, SIFMA managing director and associate general counsel, said institutional investors are more sophisticated and do not need the same protections as retail investors. "It would be unfair and inappropriate to impose a fiduciary standard on broker-dealers with respect to those institutional customers because it would allow them to basically say if my judgment turns out not to be good then I can turn to you, broker-dealer, and have you basically bear the costs of my bad choice," Mr. Carroll said.
In its proposal, the SEC did not address whether DC plan participants, like public employees not covered by the Employee Retirement Income Security Act of 1974, would be considered retail customers, and therefore covered under the package's best-interest standard, NAGDCA stated in a comment letter.
Paul Beddoe, NAGDCA's government affairs director based in Washington, said "there's just some ambiguity. We want clarification on how it applies to DC plans and participants, if at all."
SEC commissioners advanced the Reg BI package last April. Its three legs include a 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.
It also features a proposed 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.
Lastly, Reg BI compels broker-dealers to put clients' financial interests ahead of their own and requires them to mitigate financial conflicts. Critics say the proposal does not adequately define the term best interest and wouldn't establish a legally enforceable standard.
"Unless substantial changes are made in Reg BI and in the disclosures, I actually think going forward would be worse than doing nothing," said Ms. Borzi. "And it makes me sad to say that because I feel strongly that this is something that needs to be done. But I'd rather have no government action than have government action that only continues to allow people to mislead or confuse investors."
Panelists representing consumer groups echoed similar sentiments at a House Financial Services subcommittee hearing in March.
Groom Law's Mr. Kreps said he understands stakeholder concerns about the proposal but doesn't share them all. "I do think it is real standard," he said. "It is not something that can be ignored or washed away with a few disclosures. Could it be stronger or more workable? Sure, but it is a material change to people's responsibilities to their clients."
States moving forward
Several states have looked into implementing their own fiduciary standards but nothing is in effect as of yet. A fiduciary bill was introduced in New Jersey in January, and in Nevada, state regulators released a regulation proposal in January following the passage of a fiduciary duty law in 2017. A fiduciary bill was introduced in Maryland in January but was rejected in a Senate committee earlier this month.
Industry groups have called on states to delay enacting any fiduciary rules until the SEC finalizes Reg BI. In a letter to the SEC last month, SIFMA pointed to the Nevada proposal and said that state regulation of advisers registered on the federal level is prohibited under the National Securities Markets Improvement Act of 1996.
"The concern is that these state efforts will be additive, but additive in only imposing new costs and burdens on financial services firms and not additive in providing investor protections," Mr. Carroll said. "We think it's a good juncture for the SEC to perhaps remind (stakeholders) of our existing law on federal preemption of state regulations so that we can avoid that situation."
Though typically a supporter of uniform federal standards, Ms. Borzi said she's now in favor of states enacting their own fiduciary laws. "The states feel it's an obligation to protect their citizens and when they look at a federal government that doesn't seem to be up to the task…you have to say at a point maybe the states should do something."