Witnesses at a House subcommittee hearing testified March 14 that the SEC’s proposed Regulation Best Interest seemed promising at first glance, but fell short upon closer inspection.
“Putting Investors First? Examining the SEC’s Best Interest Rule,” held by the House Financial Services Subcommittee on Investor Protection, Entrepreneurship, and Capital Markets, featured a single panel of witnesses who largely criticized the proposed rule in its current form, contending that it does not go far enough in protecting investors.
The lone defender of the rule was former SEC Chairman Harvey Pitt, who is now the CEO of Kalorama Partners, a Washington, DC consulting firm. Pitt testified that he believes the SEC’s proposal was well thought out, and offers an important standard that is not too restrictive. But he added that the proposal should be considered as an initial first step and that changes could still be made.
Four other witnesses offered similar criticisms in their testimony – including that the proposal does not define “best interest,” nor does it sufficiently address conflicts of interest, and that the Form CRS is confusing. Yet, they all appeared to stop short in calling for a complete revamp, believing that the existing proposal “could be fixed.”
“While the SEC’s Reg BI may be an improvement on the status quo, it is still far too weak, and I still have several serious concerns with the rule,” Rep. Carolyn Maloney (D-NY), the subcommittee’s chairwoman, said in her opening statement. Maloney argued, among other things, that the Reg BI does not subject brokers to a full fiduciary duty, despite the staff recommendations to do so, and that it does not clearly define “best interest.” Moreover, she contended that instead of saying that brokers have to provide advice “without regard to” their own financial interests, the SEC’s rule would allow brokers to take their own interests into account.
Susan MacMichael John, Chair of the CFP Board of Standards, offered a similar assessment, citing concern that the proposals “offer the appearance, but not the reality, of increased investor protection.” John emphasized that a final rule must include explicit fiduciary protections for retail investors, regardless of the business model under which that advice is provided. “Without these critical safeguards, Reg BI not only will fail to increase protections for retail investors, it may unintentionally mislead the public by implying that compliance with the final rule will cause financial firms and professionals to recommend only those investments that are truly in a retail investor’s ‘best interest,’” John stated.
Barbara Roper, the Consumer Federation of America’s Director of Investor Protection, suggested that the “good news is that it is still possible for the SEC to adopt sufficient changes to Reg BI for the regulation to earn its ‘best interest’ label.” Roper explained that the SEC could do this without having to restart its rulemaking process, by adopting a handful of changes to the regulatory text, including clarifying what it means by “best interest” in a way that offers protections beyond those already afforded under FINRA rules. She did, however, suggest a full rewrite and reproposal of the disclosures under the Form CRS.
Investor ‘Usability’ Testing
A separate component of the hearing was draft legislation – the “SEC Disclosure Effectiveness Testing Act” – by Rep. Sean Casten (D-IL) that would require the SEC to conduct “usability testing” on the agency’s disclosure forms before finalizing Reg BI.
Under the legislation, prior to finalizing any securities regulation that calls for disclosing information to retail investors, the SEC would be required to engage in investor testing to assess whether such information will achieve the purpose intended by the Commission. This would include qualitative testing in the form of one-on-one cognitive interviews of retail investors about any such information to be provided.
While the bill has not been introduced yet, several witness testified in support of it. “Had that legislation been in place before Reg BI was proposed, the SEC might have avoided the disclosure disaster that is Form CRS,” Roper argued, suggesting that the bill would help ensure that the disclosures developed by the SEC are designed to convey information that investors are more likely to read and thus make better, more informed investment decisions.
The legislation appears to be the result of what was believed by some to be inadequate “investor testing” by the Commission on the proposed Form CRS.
Citing a RAND Corporation study conducted on behalf of the SEC, a Committee memo observes that the results of the SEC’s investor testing on the proposed Form CRS have been mixed. It notes that the Relationship Summary appears to be helpful for investors who already read the documents when choosing an adviser, and who have more investing experience, but less helpful for investors who would not otherwise read the documents.
Moreover, the memo cites a group of former SEC senior economists who recently submitted a comment letter on the proposed regulations criticizing the SEC’s economic analysis of the Reg BI's likely effects, saying that the economic analysis is “weak and incomplete.”
This legislation by House Democrats is not likely to be enacted, but it may send a subtle message to the SEC.
Witness testimony, a webcast replay of the hearing and the draft “SEC Disclosure Effectiveness Testing Act” can be found here.