Bates Research - 07-18-19

SEC Chair Responds to Seven Criticisms of Regulation Best Interest

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SEC Chair Jay Clayton

In previous posts, Bates Group looked at early reaction from SEC Commissioners and key industry players to the adoption of the new standards and interpretations that will impact the conduct of broker-dealers and investment advisers toward their retail clients. Additional articles have considered some of the reactions of state-level securities officials concerning the new rule in defense of their own state residents.

Since then, the U.S. House of Representatives weighed in and voted for an amendment to a Financial Services Appropriations bill to “prohibit[] the Securities and Exchange Commission from implementing, administering, enforcing, or publicizing the final rules and interpretations of the Securities and Exchange Commission rule entitled ‘Regulation Best Interest [Reg BI]: The Broker-Dealer Standard of Conduct’ …along with the other related issued guidance and interpretations.” House Financial Services Committee Chair Maxine Waters urged the SEC to rescind the rule, which “will only create confusion” for investors.

The amendment is not likely to pass the Senate. Senate Banking Committee Chair Mike Crapo is on record supporting the regulation, and SEC Chair Jay Clayton is not going to be rescinding the rulemaking anytime soon.

As this week’s formal publication of Reg BI in the Federal Register makes clear, the dates for implementation and compliance are set, even as the debate over the new rule package continues. In this article we review Chair Clayton’s endorsement of the regulation, and his point-by-point rebuttal of the criticism that it has received since agency adoption.

Seven Criticisms, Seven Responses

In his speech titled: Two Strong Standards that Protect and Provide Choice for Main Street Investors, Mr. Clayton acknowledged criticism from “those in support of our efforts and from those who would have preferred a different approach,” but decried criticism that “is false, misleading, misguided, … [or] is simply policy preferences disguised as legal critiques.”

Mr. Clayton stated and then rebutted the following claims:

1. That the Reg BI standard of conduct will not do enough to protect retail investors.

Mr. Clayton argued that Reg BI not only substantially enhances the standard of conduct for broker-dealers, but also affords an investor the ability to choose between a broker-dealer transaction-based model and an investment adviser portfolio-based model. He said that Reg BI “affirmatively requires broker-dealers to act in the best interest of their retail customers and not place their own interests ahead of the customer’s interests.” Further, he argued that Reg BI requires the broker-dealer to comply with four component obligations: those of disclosure, care, conflict of interest, and compliance in order to ensure this higher standard. (See here for details of these obligations.)

2. That Reg BI is deficient because it does not define “best interest.”

Mr. Clayton stated that the SEC concluded that the best approach to ensuring high standards was principle-based rather than prescriptive. He argued that a determination as to whether a broker-dealer acted in a customer’s best interest would be better assessed on an objective basis after reviewing “the facts and circumstances of how the specific components of the rule [particularly the Care Obligation] are satisfied.”

3. That the fiduciary interpretation weakens the existing fiduciary applied to investment advisers by not requiring advisers to “put clients first.”

Contrary to this claim, Mr. Clayton contends that the fiduciary guidance provided in the regulatory package actually “reaffirms the important protections that the fiduciary duty, under the Advisers Act, has long provided and will continue to provide.” He stated that the interpretation restates and formalizes what the law already requires consistent with “decades of administering this standard.”

4. That the fiduciary interpretation weakens the existing fiduciary duty applied to investment advisers by not requiring advisers to avoid all conflicts.

Mr. Clayton dismisses this claim. He says that there is no “independent legal requirement for an adviser to seek to avoid all conflicts,” and that Reg BI goes far in addressing broker-dealer conflicts of interest.

5. That the standards of conduct under Reg BI and the fiduciary interpretation can be satisfied by disclosure alone.

Mr. Clayton asserted that “Reg BI cannot be satisfied by disclosure alone.” He reiterated that the conflict of interest obligation is just one of the four obligations owed by broker-dealers under the rule and that broker-dealers “will also need to comply” with the “care obligation, which applies to every single recommendation, regardless of whether a broker-dealer has disclosed, mitigated, or eliminated its conflicts of interest.” Further, he said, an investment adviser owes both a duty of care and duty of loyalty, and, as a result, cannot fulfill these duties through disclosure alone.

6. That Reg BI is a weak standard because it does not require broker-dealers to monitor a customer’s account or impose an ongoing duty.

Mr. Clayton argued that imposing such an ongoing requirement would rob investors of the ability to choose whether they want those services and whether to incur the cost of those services. Further, he said, “Reg BI adopts a specific and tailored approach that recognizes that it would be inappropriate to apply certain generally applicable obligations of investment advisers (e.g., duty to monitor) in the context of a transaction-based relationship.”

7. That the relationship summary (CRS) will not accomplish its goals of addressing investor confusion regarding the differences between broker-dealers and investment advisers.

Noting the extensive and “even unprecedented” level of investor testing of elements of the customer relationship summary, Mr. Clayton said that it will provide “material assistance to retail investors in understanding the duties they are owed by financial service providers.” He said that “no existing retail disclosure provides this level of transparency and comparability across SEC-registered investment advisers, broker-dealers, and dual registrants.” Further, Mr. Clayton stated that “the design of the final form will result in more meaningful comparisons among firms that will be more relevant to retail investors—because they will be considering the actual services, fees and conflicts of firms in a format that allows comparability between and among firms.”

Conclusion

Given the long history of the standards debate and the final demise of the fiduciary duty rule, strong criticism of any revised approach was to be expected and will likely continue. Despite this, deadlines are set and firms should continue working to meet them. Bates will keep you apprised of developments.


Bates Group helps firms navigate the compliance challenges presented by the new Reg BI requirements. Please visit our Reg BI service page to learn more about our Reg BI implementation support, or contact Robert Lavigne, Managing Director, Bates Compliance Solutions, at rlavigne@batesgroup.com.

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