Standards-of-conduct rules approved along party lines

In a move that drew vastly different responses from two camps of stakeholders, commissioners at the Securities and Exchange Commission, in a series of 3-1 votes, approved a new standards-of-conduct package for brokers dispensing financial advice.

The commission's three Republican members, including Chairman Jay Clayton, voted on June 5 in favor of each of the package's four measures. Robert Jackson Jr., the commission's lone Democrat, dissented each time.

The package is commonly known as Reg BI, for its centerpiece best-interest standard, which compels brokers to put clients' financial interests ahead of their own and requires them to mitigate financial conflicts. Currently, brokers are subject to a suitability standard that means they must provide advice that is merely suitable to their clients' situations. Critics, including Mr. Jackson, said the measure is too ambiguous and does not establish a legally enforceable standard. The other commissioners and SEC staff who spoke disagreed.

The new rules do not affect retirement plans, except some small 401(k) plans served by brokers, said Fred Reish, a Los Angeles-based partner for Drinker Biddle & Reath LLP. But he noted that financial professionals who provide advice to retirement plan participants, including rollover recommendations, are subject to the new rules.

There were two general schools of thought on the vote. Advocates for the broker-dealer and insurance industries largely have opposed changing the current suitability standard and expanding disclosure and compliance responsibilities of these firms, noted David G. Tittsworth, a lawyer at Ropes & Gray LLP in Washington and former president and CEO of the Investment Adviser Association.

On the other side, investment advisory and financial planning groups, consumer advocates and state regulators generally have been aligned in urging the SEC to impose a fiduciary duty standard on brokers that provide investment advice to retail customers.

"This is a contentious debate that's been going on for two decades," Mr. Tittsworth said.

Since the SEC commissioners unveiled the package in April 2018, Mr. Clayton has said he wanted to preserve the broker-advice option — rather than requiring all brokers that provide advice to register as investment advisers and be subject to the Investment Advisers Act fiduciary duty standard, which is more stringent.

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

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

Lastly, the package includes an interpretation of "solely incidental" — which references a provision in the Investment Advisers Act of 1940. The interpretation exempts broker-dealers giving investment advice from registering under the Advisers Act if their advice is "solely incidental" to the conduct of their business as a broker-dealer and they don't receive "special compensation" for the advice.

The final version of the interpretation makes clear that institutional investment managers continue to be subject to the duties of care and loyalty under the well-established umbrella of the disclosure-based fiduciary duty governing advisory activities, Mr. Tittsworth said. The original version focused on an investment adviser's duty to retail customers, which led to some uncertainty as to what changes might be made.

Steve Nelson, CEO of the Institutional Limited Partners Association in Washington, said the SEC "failed to seize the opportunity to improve clarity and consistency around the fiduciary obligations that private equity advisers owe to their clients. Based on the ruling, private equity advisers will not be required to put the fund's interest ahead of their own."

In his opening statement June 5, Mr. Clayton said the package is designed to enhance the quality and transparency of the financial professional-retail investor relationship. "Broadly speaking, these rules and interpretations address the obligations of broker-dealers and investment advisers when they provide investment advice and services to our Main Street investors," he said.

Questions remain as to how the SEC will enforce the new standards, Mr. Reish said. Since regulators don't have the capacity to examine each investment recommendation, examinations initiated against individual advisers will likely be the result of investor complaints, he added.

With respect to the investment adviser standard of conduct rule, Karen Barr, president and CEO of the Investment Adviser Association in Washington, said a new interpretation is not needed. "While we are pleased that the commission seems to have made several of the clarifications we requested to the proposed interpretation, we would be disappointed if the commission dropped the most effective, widely used and straightforward articulation of the fiduciary duty — to put your client's interest first at all times — an articulation that has long framed fiduciary duty," she said.

Paul Smith, president and CEO of the CFA Institute, said in a statement that the package sets "the investor protection clock back to 2008." Critics say Reg BI is a step back from the current suitability model, but Mr. Clayton said the new rule will "substantially enhance" the standard.

Moreover, Bartlett Naylor, financial policy advocate for Washington-based consumer advocacy group Public Citizen, said in a statement that the SEC "is supposed to be a watchdog for investors, but President Donald Trump's appointees are letting Wall Street take a bite out of investors' wallets instead."

In support of the package, Kenneth E. Bentsen Jr., president and CEO of the Securities Industry and Financial Markets Association, said in a statement that Reg BI will directly enhance investor protection and contribute to increased professionalism among financial service providers. "Compliance with the rule will not be easy for the industry," he said. "Firms will need to make substantial changes. The costs to implement will no doubt be significant, but, we believe, worthwhile to uniformly enhance investor protection to the level investors should and do expect, while preserving investor choice and access to investment advice."

Investment Company Institute President and CEO Paul Schott Stevens applauded the SEC's efforts in crafting the package. "Regulation best interest will better serve investor interests by ensuring investors are afforded strong protections when they receive recommendations from broker-dealers," he said. "We look forward to engaging with the SEC and our members as they work to implement the new standards."

There was a similar dichotomy of opinions on Capitol Hill. Several Democratic lawmakers, like Sen. Elizabeth Warren, D-Mass., panned the SEC's decision. "American workers are facing a retirement crisis — the SEC should be strengthening protections for investors, not giving the green light for investment professions to trick them into buying harmful, costly products."

Republicans, like Rep. Ann Wagner, R-Mo., applauded the SEC "for taking the lead and establishing a uniform standard of conduct for broker-dealers to ensure that they will best serve their clients. Low and middle-income investors will now be protected by a strong federal standard that will hopefully avoid additional state rule-making, which would result in a patchwork of requirements and confusion for all stakeholders."

It will likely take some time for interested parties to dig through the final rules and see what's been changed from the original proposal, Mr. Tittsworth said. Since the package is far-reaching, he said he "wouldn't be surprised if there are lawsuits."

The Department of Labor, which had its fiduciary rule vacated by a federal appeals court in 2018, has said it will revisit the topic this year, following the SEC's decision.