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The SEC’s “Best Interest” Proposal – A Step Forward or a Set Back?

The SEC’s “Best Interest” Proposal – A Step Forward or a Set Back?
September 05
00:03 2018

(The second part in a series of three installments)

After years of letting the Department of Labor do all the heavy lifting, the Securities and Exchange Commission finally swung into action a month after the 5th Circuit vacated the DOL’s Fiduciary Rule. On April 18, 2018, the SEC “voted to propose a package of rulemakings and interpretations designed to enhance the quality and transparency of investors’ relationships with investment advisers and broker-dealers while preserving access to a variety of types of advice relationships and investment products.” They call it “Regulation Best Interest” and it’s been the talk of the town since this spring.

Kara Stein, the lone dissenting commission in the 4-1 vote, referred to the 1,000+ page proposal as a “squandered opportunity” that might be more appropriately called “Regulation Status Quo.”

Is Stein correct? We asked financial professionals across the nation for their thoughts on the SEC’s effort. As you might imagine, it’s clear Regulation Best Interest has some good points and some not-so-good points.

For what it’s worth, the SEC’s proposal does have the advantage of riding the momentum established by the DOL. “It is a whole additional moving force of its own on the heels of the DOL Fiduciary Rule,” says Korrine Kohm, Director of Retail Wealth Management Services, Compliance Solutions Strategies in the greater New York City area. “There is a potential to clarify to the investing public the roles and differences of brokerage firms and registered investment advisers.”

In addition to learning from the lessons offered by the DOL’s Rule, the SEC has the benefit of viewing the issue from a more comprehensive perspective. “I believe the SEC’s Best Interest proposal will enjoy wider support and less resistance as most would contend that the SEC should have taken the lead on such an issue from the beginning,” says Mike Walters, CEO of USA Financial in greater Grand Rapids, Michigan area. “Also, the SEC has a much more in-depth understanding of the industry’s inner-workings so that they should be able to craft a best-interest environment that is both conducive to advancing the industry and protecting the customer that will reach beyond just retirement advice. And do so proactively rather than enduring another confused and conflicted approach that stifled everyone including the investor.”

Last Week: DOL Fiduciary Rule Post-Mortem: How Long Will the Taste Linger? Read it now!

One of the acknowledged results of the DOL’s Fiduciary Rule is, though vacated, a broader understanding and appreciation of the meaning of “fiduciary.” This allows the SEC to start from a more advanced position than the DOL had to contend with. Duane Thompson, Senior Policy Analyst at Fi360 in Pittsburgh, Pennsylvania, says, “Of course there is now greater awareness by investors of the fiduciary standard – I think Schwab included a survey demonstrating this increased consumer awareness in their comment letter to the SEC. And if Form CRS survives – it has been heavily criticized in all quarters while it is being tested by consumer focus groups – it is very likely to change before final adoption. If the standards are sufficiently clarified, it could lead to greater awareness of differences in conduct standards that apply to different business models.”

By waiting to see how various segments of the industry responded to the DOL’s Rule – and ultimately what did it in from a legal perspective – the SEC has been able to formulate a proposal that can take into consideration the desires of both proponents and opponents of the Fiduciary Rule. “The DOL continues to seek a heightened standard for ERISA plan sponsors and others rendering investment advice,” says Ted McNamara, an attorney at Kaufman Dolowich & Voluck in Fort Lauderdale, Florida, says,. The SEC’s ‘Best Interest’ proposal incorporates some aspects of the fiduciary rule, but not others. It can be viewed as somewhat of a compromise. The SEC seeks to implement a clear rule that affords more protections to participants and investors while allowing brokers and plan sponsors to comply without overwhelming burden. For instance, under the SEC proposed rule, a broker-dealer is required to act in the best interest of its client and protect clients from investments that increase fees. However, it does not altogether prohibit commissions or other transaction-based fees protected by the Best Interest Contract Exemption.”

Still, for all the potential, Regulation Best Interest leaves a lot of questions unanswered. “If best interest truly means ‘You must act in the best interest of your client and not put your own interest in front of theirs,’ then it is a big step forward,” says Robert Johnson, Professor of Finance, Heider College of Business, Creighton University, Omaha, Nebraska. “Of course, as was the case with the Fiduciary Rule, legislating what is meant by best interest is the difficulty.”

In attempting to feature “the best of both worlds,” the SEC risks omitting requirements deemed critical by one or both sides of the issue. “The SEC’s proposal signals a desire to protect consumers through transparency but not to the extent it stymies business, commerce and transactions,” says Tad A. Devlin, a partner at Kaufman Dolowich & Voluck in San Francisco, California. “The SEC proposal does not include several disclosure requirements and restrictions on fee arrangements as mandated by the proposed Fiduciary Rule. Proponents of the Fiduciary Rule will argue that eliminating these requirements in the interest of transacting business is a step backwards.”

Not only may the final regulation leave something out, but it might not be as universally as hoped. Walters says, “The SEC’s Best Interest proposal may result in a step backwards by not being fully applicable or enforceable upon all licensed individuals equally, such as those operating with only an insurance license. Given that many of the DOL Fiduciary Rule concerns specifically targeted the sale of fixed-indexed annuities, this could leave a gaping hole in oversight that most investors will not recognize.”

Thompson adds, “There will be gaps in fiduciary coverage for retail advice where the SEC does not have jurisdiction and perhaps greater confusion over the terms ‘Fiduciary’ vs. ‘Best Interest.’ As many commenters have pointed out, the title ‘Regulation Best Interest’ will be hard to explain to consumers when comparing it to the best interest standard under the Advisers Act and add to the confusion over a true, bona fide fiduciary standard. I remember many years ago I was involved with a volunteer committee at the FPA reviewing a potential fiduciary standard for financial planners, and the task force decided not to use the word ‘fiduciary’ in its final report. However, that practice area has moved forward with CFP Board’s recently adopted fiduciary standard, so I think part of the challenge – such as we’ve seen with the SEC and state insurance regulators – is wrestling with the name itself while being less reticent in adopting components of a fiduciary standard.”

Needless to say, as we’ve learned from the DOL’s Fiduciary Rule, we’re only one change in administration away from scrapping whatever current regulators create. “The rule-making process is long, and the priorities change when administrations change,” says Kohm. “The re-addressment of the solely incidental exception to the definition of investment adviser needs to catch up with the growth since the 1980s of retail/retirement investing and protecting those investors. There has been great progress safeguarding clients’ assets and prohibiting predatory fees, but the question will remain as to whether the progress is fast enough.”

For some, the reliance on regulators isn’t seen as adding value to the industry in general and specifically to the issue of fiduciary. “Both the DOL and SEC have done more harm than good,” says Don Trone, Co-founder & CEO 3ethos in Stonington, Connecticut. “They’ve shifted the focus from guiding principles and best practices, to unrealistic rules and disclosures. One of the many unintended consequences – lawyers and compliance officers now run the financial services industry, not qualified experts. Thirty years ago when we started the fiduciary management, the singular objective was to improve the management of investment decisions. Today, the regulators have turned the movement into a political cesspool that, in turn, has attracted organizations driven solely by politics, power, ego and greed.”

The SEC may be trying to fill the void left by the vacated DOL Fiduciary Rule. Will it succeed? Does it matter? These are the questions readers might have more than a passing interest in. We’re all accustomed to that favorite SEC phrase “you can’t guarantee future results.” Speculation, nonetheless, best prepares us for the wide variety of potential scenarios down the road.

And who doesn’t want to be prepared?

Next Week: What Will the Fiduciary Standard Look Like in Five Years?

Christopher Carosa is a keynote speaker, journalist, and the author of  401(k) Fiduciary SolutionsHey! What’s My Number? How to Improve the Odds You Will Retire in Comfort, From Cradle to Retirement: The Child IRA, and several other books on innovative retirement solutions, practical business tips, and the history of the wonderful Western New York region. Follow him on Twitter, Facebook, and LinkedIn.

Mr. Carosa is available for keynote speaking engagements, especially in venues located in the Northeast, MidAtantic and Midwestern regions of the United States and in the Toronto region of Canada.

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Christopher Carosa, CTFA

Christopher Carosa, CTFA

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