SEC’s Own Investor Committee Says Reg BI Needs Fiduciary Principles
November 7, 2018 by Tracey Longo
There’s no dearth of corrective criticism surrounding the Securities and Exchange Commission’s Regulation Best Interest proposal. The latest missive comes from the agency’s own Investor Advisory Committee which today approved by a vote of 18-3 the release of an 8-page letter calling on the SEC to create explicit fiduciary principles for brokers.
Reg BI is ostensibly designed to require brokers to mitigate their conflicts of interests, which cost investors some $18 billion annually in added fees, commissions and inferior investment performance, according to an earlier White House report.
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The proposal is also supposed to elevate the sales standards brokers are held to and help consumers more easily understand what they are and aren’t getting if they hire a broker instead of a registered investment advisor, since only the latter is currently subject to a fiduciary standard.
“Our recommendation is to build on the strength of the proposal and not send the commission down a different path,” said Barbara Roper, an IAC member who wrote the recommendations. Roper is also director of investor protection at the Consumer Federation of America.
“Making it clear that both broker-dealers and investment advisers, regardless of business model, are working as fiduciaries under a standard tailored to the functions they perform would simplify the issues for investors and the regulated community alike,” the IAC said in its recommendations.
“It would eliminate the debate over whether some financial professionals are subject to a higher standard than others and thereby reduce incentives to select business models and registration status (broker-dealer vs. investment adviser) based on regulatory considerations,” the group said. “It also has the potential to greatly reduce the complexity of Form CRS [Customer Relationship Summary], since it would no longer be necessary to educate investors on the difficult to grasp differences between fiduciaries and non-fiduciaries. Rather, an investor could select his or her financial professional based on the business model that best matches the investor’s needs,” the IAC said.
The IAC is asking the SEC for the following changes to the best interest proposal:
- Clarify the obligation of both brokers and investment advisors to act in customers’ best interests.
- Expand the best interest obligation to cover rollover recommendations and recommendations by dual registrant firms regarding account types.
- Characterize the best interest rule explicitly as, a fiduciary duty, while making clear that the specific obligations that flow from that duty will vary based on differences in business models.
- Conduct usability testing of the proposed Form CRS [customer relationship summary] disclosures and, if necessary, revise them to ensure that they enable investors to make an informed choice among different types of providers and accounts.
SEC Chairman Clayton, who attended the IAC meeting, said the SEC expects to release a more detailed study specifically on form CRS [customer relationship summary] in the next several days.
“I know the staff has looked at these issues before and I look forward to reviewing them with staff,” said Clayton, who added that the agency has received some 6,000 comment letters of the Reg Best Interest proposal, 3,000 of them unique.
According to Roper: “We share the goal, expressed by Chairman Clayton and others, that the standard for broker-dealers and investment advisers alike be based on fiduciary principles designed to ensure that financial professionals act in their customers’ best interests and do not place their own interests ahead of their customers’ interests.”
A majority of the IAC also wants the SEC to clarify what it means when it states that brokers and advisers are required to act in their customers’ best interests, the report stated.
Investment recommendations should be based on investments, investment strategies, accounts, or services they reasonably believe represent the best available options for the investor, the report said.
“For example, firms would not be precluded from offering a limited menu of proprietary investment products.”
Critics pointed out, however, that brokers who offer a limited spate of their firm’s proprietary products can often cost investors significantly more in commissions, fees and inferior performance.
Indeed the IAC’s recommendations would not interfere with such practices: “Nor would our proposed approach limit brokers’ ability to earn commissions or other transaction-based payments or require them to consider investments that do not involve such payments,” the group said.
“Finally, our suggested approach would not require recommending the lowest cost option. On the contrary, as is proposed in Reg BI, our suggested approach would require brokers to take into account the full range of material characteristics of an investment, strategy, account or service in developing their recommendations,” the IAC recommendations stated.
The IAC does, however, want the SEC to expand the best interest regulation to include rollover recommendations and account type transactions that are made at the beginning of an investor’s engagement with a sales professional. “Some of the most important decisions investors make arise at the outset of the relationship, before they receive recommendations regarding specific transactions,” the IAC stated.
Both types of recommendations “inherently involve potential conflicts of interest, making it critical that advisers and brokers put their clients’ interests ahead of their own in making such recommendations.”
The IAC is also asking the SEC to professionally test Form CRS disclosures on investors to gauge its effectiveness.
“A majority of the IAC believe the disclosures should be subjected to usability testing in order to determine their effectiveness. Should the usability testing find that the disclosures do not achieve their intended purpose of reducing investor confusion and promoting informed decision-making, we encourage the Commission to work with a disclosure design expert to rectify this significant shortcoming before finalizing the document,” the committee said.
It is unclear whether the SEC’s soon-to-be-released Rand study actually tested Reg BI on investors or not—something consumer and advisor groups have also called for. SEC staff has dodged the question for months.
