Another Rollercoaster Year For A Broker-Dealer Fiduciary Standard

The SEC’s Regulation Best Interest

On June 5, the U.S. Securities and Exchange Commission (“SEC”) voted 3 to 1 to adopt a package of rulemakings and interpretations, including the controversial Regulation Best Interest (“Reg BI”) that it says will enhance the broker-dealer standard of conduct beyond the existing suitability obligation and require them to act in a retail customer’s best interest. In a press release, the SEC explained that its action balanced the need for transparency in retail investors’ relationships with investment advisers and broker-dealers with the importance of preserving access to a variety of investment services and products at a reasonable cost.

The SEC chose not to define the term “best interest” and upheld its position that a uniform fiduciary standard for investment advisers and broker-dealers is not appropriate, despite evidence of confusion among retail investors as to how these models differ in terms of compensation and conflicts of interest. Instead, broker-dealers must adhere to the following four obligations:

• Disclosure Obligation: Broker-dealers must disclose material facts about the relationship and recommendations, including specific disclosures about fees and conflicts of interest.
• Care Obligation: Broker-dealers must exercise reasonable care when making a recommendation that is in a retail customer’s best interest, taking into consideration the customer’s investment profile and the potential risks, rewards, and costs of the recommendation.
• Conflict of Interest Obligation: Broker-dealers must establish, maintain, and enforce written policies and procedures reasonably designed to identify and at a minimum disclose or eliminate conflicts of interest. Sales contests, sales quotas, bonuses, and other non-cash compensation that are based on the sale of specific products are prohibited.
• Compliance Obligation: Broker-dealers must establish, maintain and enforce policies and procedures reasonably designed to achieve compliance with Reg BI.

The sole dissenter, Democratic Commissioner Robert Jackson, stated that he voted against the package because the rules “fail to require the firms entrusted with Americans’ savings to put investor interests first” and rely on a “weak mix of measures that are unlikely to make much difference in improving the advice ordinary Americans receive from brokers.” Rick Fleming, the SEC’s first Investor Advocate, stated that Reg BI was a “step in the right direction,” but warned that much will depend on rigorous enforcement if Reg BI is to be effective.

Enforcement takes money. One vocal opponent of Reg BI seized the opportunity to block its implementation by stripping the SEC of the financial means to enforce it. Rep. Maxine Waters (D-CA), Chair of the House Financial Services Committee, sponsored a last-minute amendment to the Financial Services and General Government Appropriations Act of 2020 that covers appropriations for various federal agencies, including the SEC, for the upcoming fiscal year ending September 30, 2020. The amendment provides that none of the funds made available by the Act may be used by the SEC “to implement, administer, enforce, or publicize” Reg BI. It passed on June 26 by a vote of 227 to 200, almost entirely along party lines, and reflects the views of many Democrats that Reg BI does not go far enough to protect investors and to eliminate conflicts of interest.

From the get-go, the amendment was unlikely to pass in the Republican-controlled Senate. The budget agreement that the Trump administration and congressional leaders reached on July 22 did nothing to improve its chances. The deal states that appropriations bills this fall cannot include “poison pills, additional new riders,…or any non-appropriations measures” unless agreed to by Senate Majority Leader Mitch McConnell (R-KY), Senate Minority Leader Chuck Schumer (D-NY), House Speaker Nancy Pelosi (D-CA), House Minority Leader Kevin McCarthy (R-CA), and President Trump. The Waters amendment has a snowball’s chance of passing this bipartisan litmus test if it is to be included in the financial services funding bill that must be passed this fall to avoid another government shutdown when the fiscal year ends on September 30.

A change in administration in the next election, however, could lead to yet another reversal of fortune for Reg BI. The possibility remains open that the SEC will revisit Reg BI if a Democrat wins the White House and appoints a new commissioner more closely aligned with the views expressed by Waters and her supporters.

The DOL Fiduciary Rule

The Department of Labor (“DOL”) is not out of the fiduciary standard game yet either. On May 1, 2019, during testimony before the House Education and Labor Committee on the agency’s policies and priorities, then-DOL Secretary Alexander Acosta said that the DOL will work on a new set of rules to replace the Fiduciary Rule vacated last year.

The Fiduciary Rule was challenged in court by the U.S. Chamber of Commerce and other industry trade groups on the grounds that the DOL exceeded its rulemaking authority. The Fifth Circuit Court of Appeals overturned the Fiduciary Rule. The Trump Administration opted not to petition the U.S. Supreme Court to review that decision, and the DOL issued a non-enforcement policy.

Both moves were recently criticized by Democratic lawmakers in an open letter to the Comptroller General of the U.S. Government Accountability Office (“GAO”), asking it to examine the impact of the Fiduciary Rule on investors and the industry. Sen. Patty Murray (D-WA), Ranking Member of the Senate Health, Education, Labor & Pensions Committee, and Rep. Robert Scott (D-VA), Chair of the House Education & Labor Committee, sent the letter on the one-year anniversary of the Fifth Circuit issuing its mandate that vacated the Fiduciary Rule in toto. They faulted the DOL in the year since for having “done little, if anything, to warn retirement savers that they are now vulnerable to professionals who, according to the DOL, have no obligation to put their clients’ interest before their own.” They asked the GAO to study the extent to which firms and financial advisors assumed a fiduciary role in response to the Fiduciary Rule; whether and how many reverted after it was vacated; what changes were made to product lines and compensation structures, and the impact of these changes on sales and revenue; and overall compliance costs.

During his testimony in May, Acosta confirmed that work is being done in coordination with the SEC and Reg BI. This is more than just a nod to the SEC’s expertise. Acosta acknowledged that the Fiduciary Rule was stuck down because the agency was deemed to have exceeded its authority. To avoid another legal challenge that it may lose, the new rules may suffer from the same criticism that some have levied against Reg BI – a watered-down, disclosure-based standard of conduct with no private right of action, but one that is ultimately more palatable to broker-dealers.

Acosta would not comment on when the DOL would roll out its new set of rules, but the DOL’s updated regulatory agenda projects that it will issue a Notice of Proposed Rulemaking in December. Acosta’s resignation effective July 19, amid criticism over the 2008 plea agreement reached with Jeffrey Epstein while Acosta was U.S. Attorney for the Southern District of Florida, may delay the timeline for final rulemaking well into the 2020 election cycle.