SEC’s Best Interest vs. DOJ’s Fiduciary Rule

The de facto shuttering of the US Department of Labor’s (DOL) fiduciary duty rule this year did not come as a surprise to the financial community. Besides its tenuous political existence (See Genesis of DOL’s Fiduciary Rule and Why the Political Battle Rages On) at creation, the rule’s fate was effectively sealed with the Fifth Circuit Court of Appeal’s March 2018 decision. The question since then has been whether a reconfigured reconfigured SEC could muster the courage and wisdom to make investors accept, if not forget, the short-lived DOL rule.

As CFA Institute notes in comments submitted on 7 August in response to a trio of rule proposals, the Commission’s attempts to finally address the issue of broker advice were a decidedly mixed bag. The SEC proposals would take an important step by limiting the ability of brokers to use the “advisor” title, which obscures how the obligations they owe their customers differ from those of investment advisers. But the proposed “best interest” requirements create a complicated web of determinations, disclosures, and duties that scratch the surface of mitigating, let alone eliminating, the myriad conflicts of interest inherent in the broker business model.

A Step in the Right Direction

Nevertheless, the proposals are a step in the right direction, if not exactly far enough in that direction for our members. Recall that our support for the ill-fated DOL rule was similarly hesitant. Although the SEC doesn’t go far enough with guidance on when incidental advice is for brokers, the DOL went overboard with a complex rule structure that would have made compliance difficult and costly.

Some media outlets suggest the SEC’s rules leave elderly savers vulnerable. We argue it wouldn’t be the SEC’s rules that would lead to this uncertain outcome — the proposed rules would not, if enacted, leave elderly investors completely at the mercy of unscrupulous brokers. As part of the Commission’s three-part, best-interest test, brokers would need a reasonable basis for believing that

1. their recommendations could be in the best interests of some retail customers in the general population;
2. their recommendations could be in the best interests of particular retail clients such as the client to receive the recommendation; and
3. that a series of recommendations would be in that client’s overall best interests given the client’s investment profile.

Brokers’ firms would have to publish policies and procedures directing brokers to incorporate this test, as well as how to address conflicts of interest that naturally arise in sales situations. The Commission contends this latter provision will enable more effective and efficient enforcement. Actions, of course, will speak louder than these words.

At the launch ceremony for the DOL’s proposed fiduciary duty rule in early 2015, the government estimated that $1.7 trillion in retirement investment assets—of an aggregate $24.7 trillion in total retirement assets—were at risk of mis-selling. The potential overcharges to retirees and retirement investors in this at-risk pool was estimated at $17 billion per year.

By comparison, today, the total market capitalization of US securities markets combined with the face value of US Treasury securities markets in the hands of investors is nearly $50 trillion. Although not perfect, the SEC’s proposed rules would apply universally to brokers and advisers who, in one way or another, direct investors into most of these investable assets. The improvements within the SEC’s rule, therefore, should benefit investors of all types.

Significant Investor Interest

The Commission has much to consider. Such is the interest of US investors in the SEC’s proposals that as of 5 August, it had received more than 2,430 unique comments on its Regulation Best Interest proposal, alone, to go along with more than 3,800 form letters submitted by individuals aligned with several different advocacy groups. It also received investor input from

• four investor roundtables;
• an Investor Advisory Committee meeting in Atlanta in June, which included CFA Institute as a presenter;
• 75 face-to-face meetings with interested parties as of 1 August, including just one of eight such meetings CFA Institute had with SEC commissioners and staff since January; and
• 160 comments received on its Form CRS proposal, and a further 50 considering its investment adviser standards interpretation proposals.

The commissioners and Commission staff still face the unenviable task of wading through all this input, with the ultimate goal of producing sensible and coherent final rule proposals. Between now and then, they will no doubt  engage in additional face-to-face meetings with CFA Institute and others as well, all attempting to persuade the SEC to adopt final rules that adhere closely to each organization’s or individual’s points of view. Once that process is complete, the SEC’s commissioners will take an “up-or-down” vote. of the commissioners. At this early date, it is difficult to tell which way those winds will blow.

Moving Beyond the SEC’s Jurisdiction

Should the Commission approve a better-than-the-status-quo final rule, its rule would still only cover securities brokers and investment advisers. Insurance agents, in particular, reside in a jurisdiction beyond the SEC’s authority, operating under each state’s insurance regulatory regime. The selling of fixed annuities to retirement investors, therefore, would remain a potential source for mis-selling by sales agents who could continue to call themselves “financial advisors.”

Consequently, the DOL is likely to take center stage again for those wanting better investor protection for retirement investors. The DOL’s oversight of ERISA rules, including those related to individual retirement accounts, would be needed to expand to the rest of the retirement advice market whatever improvements come from a final SEC rule. Likewise, state insurance regulation should become a focus of investor protection advocacy nationwide. State legislators and insurance commissioners need to recognize the need to address mis-selling by insurance agents. CFA Institute will be part of both efforts, encouraging our local and state society advocacy committees to join the effort and working with them as they do so.

Much Work Remains

The submission of letters to the SEC is complete. That milestone, however, represents merely the end of the beginning of the decades-long effort to improve regulation and oversight of broker recommendations. Significant work remains to secure whatever hard-fought gains come from the SEC’s final rules and to ensure their broader application in the investment landscape.

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Photo Credit: ©Getty Images/Tanya St