The Securities and Exchange Commission’s August 7 deadline for submitting comments on its proposed regulation best interest, Form CRS relationship summary and interpretation regarding standard of conduct is quickly approaching.
No doubt the agency will receive numerous comments in the days ahead, but a review of some of the comments the agency has received so far reveals a wide range of opinions on the proposals.
AARP Grassroots Campaign
The SEC has received hundreds of comments resulting from AARP’s grassroots campaign under the heading “Stop financial advisers from sapping Americans’ retirement savings.” The individuals write that they are counting on the SEC “… to make a stronger rule that closes the loophole. Americans who've worked hard to save for retirement deserve peace of mind about their financial security.” Many of the letters do not appear to define what “loophole” they are referring to, but it is presumed that they are referring to so-called “conflicted advice” and making sure advisors are “obligated to disclose all fees and make recommendations that are in the best interest of the client.”
Industry Stakeholders
Beyond the comments that appear to be generated from a grassroots campaign effort, the proposed Regulation Best Interest, as well as the Form CRS relationship summary and interpretation regarding standard of conduct, have received approximately 30 industry- and stakeholder-led comment letters that go more in-depth in offering suggestions for improving the proposals.
For example, comments from the Committee on Capital Markets Regulation commend the SEC for submitting the proposals, believing that it is “an appropriate time to adopt a best interest standard applicable to broker-dealers making recommendations to retail customers that applies uniformly to all account types.”
The group notes, however, that is has three concerns with the proposals. The CCMR suggests, among other things, that the Regulation Best Interest contains standards that the SEC states will be evaluated based on the totality of the circumstances and will thus be subject to significant interpretation.
“We agree with a principles-based approach but emphasize that the SEC will need to work closely with the industry to provide feedback and guidance as the regulation is implemented,” the comment letter states. The CCMR also contends that the Form CRS Relationship Summary is “excessively complicated” and should be shortened and simplified with supplemental disclosures made available online. Finally, the group suggests, along with many others, that any Department of Labor rules regulating broker-dealers under ERISA and the Internal Revenue Code should be made consistent with the SEC’s regulation of broker-dealers and the proposals.
Melanie Fein of the Fein Law Offices applauds the SEC for proposing to clarify the standards applicable to broker-dealers when they give personalized investment advice to retail customers, but suggests that the proposal is incomplete.
Fein notes that the “best interest” standard on its face is a fiduciary standard and brokers operating under it will be fiduciaries under widely recognized common law fiduciary principles: “The failure to attach the label of ‘fiduciary’ to brokers when they clearly act in a fiduciary capacity will undermine the Commission’s intent to mitigate confusion by retail investors when they seek personalized investment advice.” She further contends that brokers will not consider themselves fiduciaries and investors still will not know the difference between a broker and an investment adviser.
Fein emphasizes that the Commission’s proposed “best interest” standard is a fiduciary standard in the “classic sense of the term, no less so than the existing standard in FINRA’s Suitability Rule or the fiduciary standard applicable to investment advisers under the Investment Advisers Act of 1940, or indeed the Uniform Prudent Investor Act.” She emphasizes that brokers that make investment recommendations in accordance with the Commission’s proposed best interest standard will be acting as fiduciaries just as brokers currently acting in accordance with FINRA’s Suitability Rule are fiduciaries. “It thus is misleading for the Commission to disavow that brokers are ‘fiduciaries’ when they give investment advice to retail investors and that Regulation Best Interest does not embody a fiduciary standard,” Fein states.
She further notes that the “…irony is that Regulation Best Interest imposes a far more explicit and robust fiduciary standard on brokers than applies to investment advisers,” further suggesting that the SEC should acknowledge that brokers are fiduciaries when they provide personalized investment advice to retail investors and should adopt a uniform fiduciary standard for both brokers and investment advisers in accordance with the Dodd-Frank Act.
‘Investor Diversity’
Temple University Law Professor Tom C.W. Lin suggests that the SEC should consider refining the proposals to better reflect the “unprecedented investor diversity” in today’s marketplace, noting that the markets consist of a diverse population of retail investors. “Today’s investors, including retail investors, have varying investment timelines, objectives, means, and ‘best interests,’” Lin writes. “As such, while it is important to protect every retail investor, it is also important to acknowledge that not every retail investor is the same, and thus not every investor needs the same type of protection.”
Lin further recommends that the Commission should consider the “limited utility of disclosure” as a primary means of protecting retail investors and ensuring their “best interests,” as detailed in the proposals. Moreover, he suggests that the agency consider the additional regulatory complexity and compliance costs the proposals “could add to current broker-dealers and other financial institutions, and how these burdens may ultimately lead to higher costs and less competition to the detriment of retail investors.”
Wirehouses’ Input
A few anonymous letters from operations managers for leading wirehouse firms commented that they believe the best interest rule has its merits and can potentially protect investors, but only if the SEC can coordinate its efforts with all regulatory bodies including the CFP Board and the NAIC.
The letters explain that those who work at wirehouses or “reputable broker dealers” must have certain transactions reviewed and/or pre-approved, but many CFPs that charge fees have no supervision or compliance departments reviewing their recommendations or services or portfolios. One letter suggests that the CFPs believe they were excluded from the DOL rule because they only charge a fee and not a commission. These anonymous operations managers say they have had many new clients come to them saying they were recommended out of their 401(k) plans or pension plans only to be put into a managed IRA accounts and later find out that they lost their NUA status or age 55 exemption on their 401(k) plan, or end up with huge penalties from the IRS because they messed up on Section 72(t) early distribution rules, which were not properly explained to them.
The commenters contend that the most “investor abuse” taking place is in the index/fixed annuity side of the industry. “The problem is not the brokers or commissions or the broker dealers; it is having a rule that applies to every one across the board, all securities, all fee professionals, all products including insurance; and particularly those investments sold by independent insurance agents and general agents that do not appear to have a current pre-approval process in place,” writes one anonymous commenter. “Unless this can be accomplished, you will continue to have investors being taken advantage of,” the commenter adds.
Still Waiting on DOL
Meanwhile, there hasn’t been any news from the Labor Department since the agency and Thrivent, both still pending litigants, filed a “joint status report” on July 2 agreeing to continue a stay of proceedings and to provide a subsequent report to the Court on Sept. 4, 2018, in a case before the U.S. District Court for the District of Minnesota (Thrivent Fin. for Lutherans v. Acosta).
This comes amid the 5th Circuit Court of Appeals' June 21 issuance of its mandate vacating the Labor Department’s fiduciary rule and the July 13 closure of any further proceedings for this case (U.S. Chamber of Commerce v. DOL).
The status report in the Thrivent case cited the 5th Circuit’s decision, the June 21 filing and a June 28 order by Judge Barbara Lynn of the U.S. District Court for the Northern District of Texas asking any party seeking further relief to notify the court of that intent by July 12. Judge Lynn on July 13 closed the case administratively. The industry groups that first challenged the rule indicated that they would not seek any further relief.
“Based on the foregoing, the parties agree that the stay of proceedings should continue for the present time and anticipate providing a subsequent report to the Court on September 4, 2018. The parties will inform the Court of any substantive updates in the meantime,” the status report concludes.
Also, it’s worth repeating that on May 7 the DOL issued Field Assistance Bulletin 2018-02 announcing that it was extending until further notice its temporary enforcement policy relating to its rule defining who is a fiduciary and the associated prohibited transaction exemptions.
The fiduciary regulation’s demise notwithstanding, the FAB is important because, even though the BIC Exemption has been set aside along with the rest of the rule, what the FAB essentially does is to provide for non-enforcement where the impartial conduct standards set forth in the BIC Exemption – which was in the fiduciary rule – are satisfied.
Since the BIC Exemption was the only “clearly applicable” exemption for IRA rollovers, it contains the most reliable guidance we have on what the DOL thinks “best interest” means in the context of a rollover recommendation, according to Drinker Biddle & Reath’s Fred Reish and Joshua Waldbeser.
