Although the Department of Labor’s (DOL) fiduciary rule has officially been shelved, many in the financial sector are still pushing for implementation of an industry-wide fiduciary standard. The DOL, as well as the Securities and Exchange Commission (SEC), the Financial Industry Regulatory Authority (FINRA) and several state attorneys general are all seeking solutions that protect investors and maintain regulatory clarity.
Interested parties are awaiting the fine tuning and adoption of the SEC’s proposed “Regulation Best Interest (Reg BI),” which recently concluded a 90-day comment period. Meanwhile, many are looking also to post-fiduciary-rule guidance from the DOL, which is expected soon, as well as state-level legislation. With so much going on, a comprehensive overview of reform efforts may be in order.
SEC Regulation Best Interest
The SEC’s Regulation Best Interest is the best bet for those hoping for a broad-based fiduciary standard since it would apply to all securities transactions, including those in Employee Retirement Income Security Act (ERISA) plans and IRAs. The downside of this is that the standard falls somewhere between “suitability” and “fiduciary” and is not clearly defined by the proposed regulation.
Reg BI prevents broker-dealers and related persons from using the term “adviser” or “advisor” when communicating with investors. The regulation also clarifies the fiduciary duties of Registered Investment Advisors (RIAs), sets new and amended rules and forms that require RIAs and broker-dealers to provide relationship summaries to clients and establishes rules requiring broker-dealers, RIAs and related persons to disclose both registration status and their relationship to retail investors.
Almost as soon as the SEC’s Reg BI became public, questions about the lack of clarity regarding the definition of “best interest” arose. Others have questioned the suitability of the current definition of the term “retail customer,” pointing out that it appears to apply to individuals, including their accounts in retirement plans, IRAs, custodianships, guardianships and personal trusts, but not to business accounts or to retirement plans. This raises concerns about the applicability of the “best interest” standard.
In theory, the regulation is still set to change. The SEC’s 90-day comment period allowed interested parties to voice concerns and propose fixes, which the SEC will take into consideration before implementing the regulation. (For more see: Next Target for Lobbyists: SEC Best Interest Rule.)
Reg BI Comment Period Ends
By the time the SEC Reg BI comment period ended on August 7, the regulation received more than 3,800 comments. SEC officials also held public meetings and conducted investor roundtables to seek advice and input.
One prominent commenter, Ken Fisher, founder of Fisher Investments, called for the SEC to enforce the existing Investment Advisers Act of 1940 instead of creating a new rule. Fisher proposed that the SEC strictly enforce the “solely incidental” language in the Act for a broker’s brokerage activities and providing a distinct “broker-adviser” title for those who are dually registered.
Current Reg BI language allows dual registrants to keep the title of adviser but requires that they clearly inform the client when they are acting in either role. Fisher wants to retain language providing role clarity (or by requiring different colored disclosure documents or through other disclosure mechanisms) and would further mandate that insurance salesmen, financial planners and others be prevented from calling themselves “advisers.”
Other commenters called for simplification of best interest guidelines, the customer relationship summary form and other documents in the legislation. Additional suggestions included requiring brokers to call themselves “salespersons” and allowing exemptions for small broker-dealer firms. Still others suggested scrapping the proposed best interest regulation altogether.
Now it’s up to agency staff to review comments and other feedback and make a recommendation to SEC commissioners about possible next steps. Although a specific timeline for implementation of the regulation has not been establishe – SEC chairman Jay Clayton stated simply that the agency, “is not going to take forever” – Blaine Aikin, executive chairman of Fi360, has suggested it will likely be another year before a final rule is adopted. “Under the best circumstances,” Aikin told advisers, “after the deadline for comments, there will be a reassurance of the proposed rule, another comment period is most likely, and then further revisions.”
The Role of FINRA and the SEC
Parts of the proposed SEC standards were taken from the suitability standards reflected in the rules imposed by FINRA on its members. In general, these standards are more flexible than those of the DOL fiduciary rule. The “best interest” section is new and controversial in the sense that by not providing a concrete definition of “best interest,” the SEC elected to let the facts and circumstances of each case decide the outcome. Because of this, both the SEC and FINRA will play a huge role when it comes to interpretation and compliance with Reg BI. Broker-dealers have been urged to examine FINRA’s 2013 Report on Conflicts of Interest to provide some guidance on how that organization may view implementation of the new SEC rule.
Meanwhile, pressure from Democrats in the House and Senate, especially if the party takes over either (or both) chamber(s) this fall, could influence how both the SEC and FINRA interpret Reg BI. Democrats believe the SEC proposal is too weak and top Democrats on the Senate Banking Committee call it “confusing and ambiguous.” They argue in favor of a uniform true fiduciary standard for all retail investment advice and want to hear more from FINRA about how it would interpret and apply the new rule. While chances of Democratic legislation and enforcement standards making their way through both chambers is considered slim, observers believe the effort alone would be enough to get the SEC’s attention.
Additional DOL Fiduciary Rule Guidance Coming
Meanwhile, the vacating of the DOL’s fiduciary rule on June 21 by the U.S. Court of Appeals for the Fifth Circuit resulted in the removal of the fiduciary rule from federal law while still allowing financial institutions to rely on the Best Interest Contract exemption (BIC exemption). Otherwise, the result signals a return to pre-fiduciary rule conditions.
With the original implementation of the DOL fiduciary rule, many financial institutions changed their business models and sales practices to comply with the new law. Now these institutions find themselves revisiting their changes. As with implementation of SEC Best Interest, the “nature and timing” of DOL’s new guidance is uncertain, according to George Michael Gerstein, co-chair of Stradley Ronon’s Fiduciary Governance Group. (For more see: DOL’s Fiduciary Rule Officially Shelved)
DOL and SEC efforts notwithstanding, several states have attempted to enact fiduciary standards of their own. While some states began working on their own legislation well before the DOL fiduciary rule was adopted, others have joined in more recently.
Among the states that have already enacted legislation is Nevada, where lawmakers passed a law last year extending the state’s existing fiduciary law to include financial planners, stockbrokers and other commission-based representatives. Connecticut has also adopted legislation, while New York and New Jersey are considering state-based fiduciary laws. Similarly, the Maryland state senate recently asked its consumer protection agency to weigh in on whether the state should enact its own fiduciary law.
Meanwhile, courts in California, Missouri, South Carolina and South Dakota have imposed fiduciary standards on broker-dealers, and the state of Minnesota has expressed interest in enacting some type of fiduciary protection. Observers expect more state-level action in coming months, especially if Democrats win majorities in statehouses or take over more governors’ mansions in upcoming elections.
According to fiduciary law expert James Watkins, federal law does not supersede the rights of states to pass fiduciary law. “So long as states enact fiduciary laws that don’t impact [ERISA plans] like 401(k)s,” Watkins said, “they have every right to act.” Many in the financial services industry oppose state-level action claiming different rules for each state would make training, supervision and implementation too complicated.
The demise of the DOL fiduciary rule and the rise of SEC Best Interest and state-level fiduciary legislation, coupled with an evolving political landscape have all created a climate of confusion for financial institutions, advisors and investors. What is certain is that public attention is more focused on financial service providers and how they do business than ever before.
Despite current regulatory uncertainty, securities regulators, FINRA and state attorneys general have plenty of tools available to investigate and deal with those who engage in questionable sales practices. Responsible practitioners will continue to follow a best interest guideline as they have always done and eventually clarity will come.