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By: Theodore C. Peters
The Securities and Exchange Commission (“SEC”) conducted a public hearing on April 18, 2018 to address a series of SEC proposals governing securities professionals. Recall that the Department of Labor previously sought to promulgate a “fiduciary rule” which encountered numerous legal hurdles and ultimately was struck down by the Fifth Circuit. Concurrently, over the last 11 months, the SEC has been working on its own set of rules to provide the securities industry with more clarity concerning advice standards. After a two hour hearing, the SEC Commissioners split over whether to proceed with the next step in the rule making process. Chairman Jay Clayton and Commissioners Michael S. Piwowar, Robert J. Jackson Jr. and Hester M. Peirce voted in favor of the proposals; Commissioner Kara M. Stein vociferously rejected the proposals.
At issue were three proposals: (1) a rule to establish a standard of conduct for broker-dealers and their associated persons when making a recommendation of any securities transaction or investment strategy involving securities to a retail customer; (2) a rule requiring registered broker-dealers and registered investment advisers to provide a brief relationship summary to retail investors; and (3) a formal SEC interpretation of the standard of conduct applicable to investment advisers. Various SEC staffers introduced each of the proposals with candid remarks, tacitly admitting that there was room for improvement with respect to each component of the proposal package.
The so-called “Regulation Best Interest” would mandate that broker-dealers and their registered representatives who make recommendations to a retail customer act in the best interest of the customer at the time the recommendation is made, without putting the financial or other interest of the broker-dealer ahead of the retail customer. To comply with this obligation, a broker-dealer would need to do three things: (1) disclose key facts about the relationship (including material conflicts of interest); (2) exercise reasonable diligence/care/skill to i) understand the product, ii) have a reasonable basis to believe that the product is in the customer’s best interest, and iii) have a reasonable basis to believe that a series of transactions is in the customer’s best interest; and (3) establish/maintain/enforce policies and procedures designed to identify and disclose and then mitigate or eliminate material conflicts of interest.
The Form CRS (customer relationship summary) rule would require investment advisers and broker-dealers (and their associated persons) to provide retail investors with a short-form (4 pages maximum) disclosure summary that would identify key differences in the principal types of services offered, the legal standards of conduct that apply to each, applicable fees and conflicts of interest.
In connection with the proposal regarding a Commission interpretation of the standard of conduct for investment advisers, the SEC seeks a Commission-sanctioned interpretation as to the duty owed by an investment adviser to his/her clients. The proposed interpretation reaffirms, and in some cases clarifies, certain aspects of the fiduciary duty owed by an investment adviser.
Republican Commissioner Michael Piwowar candidly admitted that the failed DOL Fiduciary Rule was “terrible,” “horrible,” and “very bad.” He expressed greater faith in the SEC proposals, though he said that the proposals could be improved in several respects. He stated that the proposed Regulation Best Interest represented a “solid building block,” but noted that there was much room for improvement. As for the proposed Form CRS template, Piwower suggested that it was “as comprehensible as Herman Melville’s Moby Dick.” Despite having misgivings as to all three proposals, he voted in favor of them.
Democratic Commissioner Robert Jackson, who admitted being an advocate of the DOL Fiduciary Rule, also professed to have concerns over the proposals. He stated that the standard set forth in Regulation Best Interest was too ambiguous and he feared that such ambiguity would be used by lawyers to defend transgressing brokers. As for the proposal concerning mitigation of conflicts of interest, Jackson stated that “some conflicts should simply be banned outright.” Despite his concerns, Jackson stated that he was “reluctantly voting to open the proposals for comment.”
Republican Commissioner Hester Peirce concurred with many of the prior comments concerning clarity (or the lack thereof) of the proposals. She stated that “disclosure should be the centerpiece of reform,” and that she was in favor of requiring brokers to provide more details in connection with their disclosures of services offered and fees charged. Peirce believes that the proposed Regulation Best Interest was mislabeled, stating that it would be more accurate to call it a “suitability-plus” standard. Lack of clarity in the proposal leads to increased cost of compliance, Peirce said, and suggests an “impossible standard” to satisfy which could lead to a decline in the number of registered broker-dealers. Commissioner Peirce stated that the proposals were an “excellent start toward reform,” and voted in favor of them.
Democratic Commissioner Kara Stein blasted the proposals as too weak. She said the Commission had the opportunity to propose meaningful proposals, but failed to do so. Critically, Stein said the Regulation Best Interest provided broker-dealers with a safe harbor and did nothing to require that they put customers’ interests first. Noting that the proposed regulation lacked any definition of “best interest,” Stein said the proposal might mislead investors and might as well be called “Regulation Status Quo,” because it simply reaffirms that broker-dealers are required to meet their suitability obligations. Not surprisingly, Commissioner Stein voted against the proposals.
Chairman Jay Clayton acknowledged his fellow Commissioners’ comments and stated that “much work” was still needed before the proposals could be adopted as final rules. Calling for a vote, Commissioners Piwower, Jackson, Peirce and Clayton voted in favor; Commission Stein voted against. With majority approval, the SEC’s rule package will now be submitted for a 90-day public comment period.
If you have questions or would like more information, please contact Ted Peters at [email protected].