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Legal Experts See Long Road Ahead for SEC Proposals

Leading ERISA legal minds believe the Securities and Exchange Commission’s proposals to establish new standards of conduct for broker-dealers (BDs) and investment advisers (IAs) still need a lot of work.

The SEC on April 18 voted 4-1 to release for public comment two new rules and one new piece of interpretative guidance. Under the two rules, a “best interest” standard of care for BDs would be established, along with a new Customer Relationship Summary (CRS) form, which both BDs and IAs would be required to provide to retail investors that describes the relationship in plain English. In addition, the interpretive guidance would restrict certain BDs and their financial professionals from using the terms “adviser” and “advisor” as part of their title with retail investors.

Attorney Fred Reish with Drinker Biddle & Reath noted that the proposals, despite being nearly 1,000 pages, are “surprisingly incomplete,” adding that this is particularly true of the Regulation Best Interest and the Customer Relationship Summaries. “I don’t know why they weren’t further developed before being issued, unless the SEC rushed to get the proposals out the door,” Reish notes. For example, he explains that the Best Interest regulation does not define “best interest.” Because of that, he says, it is almost impossible to appreciate the standard of care being imposed.

In fact, the attorneys interviewed point out that many of the commissioners expressed concern with the proposals. “Of note, it is interesting that many of the commissioners – representing both sides of the political aisle – expressed concerns about the proposed SEC guidance as it stands now, so I think we have a potentially long road ahead,” explains David Levine of the Groom Law Group.

Marcia Wagner of The Wagner Law Group adds, “To put this in context, although the vote to release the proposal was 4-1, four of the five commissioners had serious misgivings about the proposed package, so the final version of the regulations may be substantially different, although it would be surprising if the final version of Regulation Best Interest were to treat broker-dealers as fiduciaries, because that would be inconsistent with a basic premise of the guidance that the investment advisor and broker-dealer models are two separate and distinct business models.”

Wagner notes that there was some expectation that, consistent with the authorization to the SEC under the Dodd-Frank Act, there would be a uniform fiduciary standard for RIAs and BDs, and the SEC will undoubtedly receive numerous comments upon their failure to adopt such an approach. “To the extent that broker-dealers had already undertaken actions to comply with the DOL fiduciary rule, they should not require many additional actions, although the additional disclosure in Form CRS will be a new obligation not called for under the DOL rule,” Wagner states.

Levine notes that “the proposals create a framework that will, in some ways, look like the DOL’s fiduciary rule structure although with fewer black-and-white lines and requirements.” He anticipates that BDs, RIAs and other industry participants will have a number of comments, but believes the proposal is “likely to face less pushback from BDs and RIAs than the DOL rule received.” He adds that the industry should expect focused comments (as noted throughout the proposed SEC guidance) from consumer advocacy organizations pushing for protections more like those in the DOL rule.


When asked how the SEC package compares to the DOL rule, the attorneys noted that the rules are similar in many ways, but explained that there are some key differences, particularly with the enforcement regime.

Reish explains that the Regulation Best Interest proposal has a specific section that compares the proposal to the DOL transition rule under the Best Interest Contract Exemption (BICE). While the rules are very similar, the consequences of a violation will be slightly different, he notes. “A violation of the DOL’s BICE will be both a prohibited transaction and a breach of fiduciary duty or, more technically, a breach of the best interest standard of care,” he observes. But a key difference, Reish adds, is that a breach of the SEC’s best interest standard would not create a private right of action, meaning that an investor cannot file a claim for a violation. In other words, only the SEC or FINRA could enforce the standard, but it’s possible that FINRA could allow arbitration claims to be filed, Reish says.

Levine also notes that the SEC package is similar to the DOL rule, and in fact, the DOL rule is referred to more than 100 times. “The new Regulation Best Interest standards proposed for BDs is, as the SEC notes, definitively in excess of the FINRA suitability rule standards, and, in fact, often feels like a restated version of the DOL’s impartial conduct standards and BIC exemption requirements,” Levine says. “Where the rules diverge is not so much in what care is required so much as the DOL provided a prescriptive compliance roadmap while the SEC, for now, has offered a more open-ended landscape.”

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Levine also notes that the scope of the rule as applying to “retail investors” does not perfectly align with those covered under the DOL rule which raises some interesting compliance questions if the DOL does not appeal the 5th Circuit decision.

Similarly, Wagner observes that, although the approach taken by the SEC seems borrowed from the DOL rule, by choosing not to treat broker-dealers as fiduciaries, the SEC is clearly imposing a lesser standard of conduct on BDs than the DOL imposed in its fiduciary rule.

Moreover, Wagner adds that “the absence of a private cause of action as an enforcement mechanism, while understandable from a legal perspective, raises serious questions about how the Regulation Best Interest rule would be enforced in practice.” She further observes that the SEC approach not only relies more heavily upon disclosure than the DOL, it doesn’t go as far as the DOL did in eliminating conflicts of interest. “Notwithstanding these differences, the DOL may believe that the SEC guidance would provide a cover for not appealing the 5th Circuit decision,” Wagner suggests.

Best Interest Definition

Addressing the proposal’s lack of a specific definition of “best interest” and whether it would be unenforceable, the attorneys noted that, as was the case with the DOL rule, there likely will be a wide range of views on the Regulation Best Interest.

“Given the multiple layers of compliance in the Disclosure, Care, and Conflict of Interests Obligations, where there is a lot of flexibility, it doesn’t automatically seem ‘unenforceable,’” notes Levine. He adds that the SEC’s lengthy list of questions and requests for comments highlights that there is a lot of tweaking that may be made to this proposal that could push it in either direction.

Adds Wagner, “It is true that the SEC did not define ‘best interest,’ under the Regulation Best Interest, but neither did Section 913(g) of the Dodd-Frank Act, nor FINRA guidance imposing that standard of conduct on broker-dealers.” She explains that the absence of a bright-line definition does not necessarily make a legal standard unenforceable. Instead, the SEC’s approach in the current proposal is that the determination of a retail customer’s best interest requires a facts-and-circumstances analysis, and focuses upon the retail customer. “From the perspective of a broker-dealer, this approach is not necessarily preferable to a bright-line definition, because it may be difficult to determine if you not only took all of the customer’s factors into account and gave them the appropriate weight, and a fact sensitive determination may be more expensive and time consuming, but it is a manner in which legal matters are often resolved,” Wagner explains.

Form CRS 

As for the new proposed Form CRS, the attorneys believe that changes likely will need to be made, with one going as far to say that they are “confusing,” in many cases “inaccurate” and “not ready for prime time.”

For example, Reish notes that the brokerage CRS says that when investments in a brokerage account are sold, there is a commission. He explains that, “while that is the case for some types of investments, it is not for others; for example, A share mutual funds.”

In addition, he observes that the forms say that an investment adviser is a fiduciary, but suggests that the typical retail investor does not know what a fiduciary is, what a fiduciary does, or what a fiduciary standard of care is. Similarly, he notes that the forms refer to “best interest,” but also doubts that the typical investor knows what that means or perhaps believes that it is a much higher standard than “fiduciary.”

For his part, Levine observes that the new Form CRS disclosure requirements for BDs and RIAs evoke many of the disclosure requirements in the DOL rule disclosures — albeit simplified. “As many of the Commissioners from both sides of the aisle noted, it may need revision to make it ‘easy to use’ for the retail investor while also not being too generic to be helpful,” he observes, adding that making documentation readable but useful "is the eternal challenge.”

Wagner notes that there are two difficulties with any disclosure mode of compliance: will the recipient actually read the disclosure, and will it in fact be “concise and direct” as the SEC is requiring? “The point isn’t that a four-page disclosure statement is too long in the abstract, and if it was written in a reader-friendly manner the form would be useful, but it is difficult to be confident of either of those premises,” she says.