SEC seeks to extend principal trading rule — yet again

Fiduciary advocates worry that the Advisers Act is being undermined

The Securities and Exchange Commission is seeking to extend for two years a rule that allows investment advisers who are dually registered as brokers to sell stocks and bonds from their firm’s product inventory, to the dismay of fiduciary advocates.
Under the rule, advisers can engage in principal trading without providing disclosures and getting written consent on each trade. Instead, they can provide disclosures on a prospective or annual basis.
The SEC is proposing to continue the rule to Dec. 31, 2014. The current rule is set to expire at the end of this year.
The SEC will take public comment on the proposal for 30 days, after it is published in the Federal Register.
ADOPTED IN 2007
The SEC originally adopted the rule on an interim basis in 2007 to permit brokers to sell proprietary products to advisory clients. The rule responded to a federal appellate court decision that held that brokers offering fee-based accounts were subject to the prohibitions of the Investment Advisers Act of 1940.
It was extended in 2009 and again in 2010.
The SEC said that another extension is necessary as it determines whether to proceed with a regulation that would impose a uniform fiduciary standard of care for retail investment advice.
“We believe the requirements of [the principal-trading rule], coupled with regulatory oversight, will adequately protect advisory clients for an additional limited period of time while we consider more broadly the regulatory requirements applicable to broker-dealers and investment advisers,” the SEC proposal states.
That assertion doesn’t comfort those in favor of a universal fiduciary standard, who contend that principal trading makes investors vulnerable to brokers’ dumping underperforming securities into their accounts.
Clients may not be fully informed of the scope of conflicts of interest in principal trading if they are disclosed only generally at the outset or summarized annually, according to Duane Thompson, senior policy adviser at fi360 LLC.
“The quality of disclosure to clients is diluted under the temporary rule,” Mr. Thompson said.
Investment advisers, who must act in their clients’ best interests, are prohibited under the Advisers Act from conducting principal trading. Brokers adhere to a less stringent suitability standard that permits principal trading.
Knut Rostad, president of The Institute for the Fiduciary Standard, worries that the 1940 law is being undermined by the temporary principal-trading rule.
“I’m concerned that extending the rule has the impact of — against all experience — helping redefine conflicts of interest from something bad to something virtuous,” he wrote in an e-mail.
The SEC said in the proposal that transaction-by-transaction written disclosure and consent requirements would limit the investment products available to advisory clients of brokers.
“We believe the principal benefit [of the rule] is that it maintains investor choice and protects the interests of investors,” the SEC proposal states. “[The rule] also provides nondiscretionary advisory clients easier access to a wider range of securities by providing a lower-cost and more efficient alternative for an adviser that is registered with us as a broker-dealer to comply with the requirements of … the Advisers Act.”
The SEC said that it hasn’t recorded instances where brokers have used the temporary rule to dump unmarketable securities into customer accounts.
As the interim rule takes on a life of its own, the SEC must carefully track compliance problems, according to Dan Barry, managing director of government relations at the Financial Planning Association.
“The temporary extension makes sense as long as there is a [uniform] fiduciary rule somewhere in the offing,” Mr. Barry said. “If a fiduciary rule making is in significant doubt, they should start looking at the temporary principal-trading rule as if it has some permanence.”