SEC advice rule raises bar for brokers by putting 'best interest' on table

Required policies, procedures give the regulator a way to gauge brokers' follow through on mitigating conflicts

Apr 19, 2018 @ 2:41 pm

By Mark Schoeff Jr.

A Securities and Exchange Commission proposal to curb conflicts of interest for brokers comes with compliance requirements that give the regulation teeth, according to securities lawyers.

In a 4-1 vote Wednesday, the SEC advanced a package of advice-standard measures that included a so-called "Regulation Best Interest" for brokers. It requires that brokers put their clients' needs ahead of their own desire to make the most revenue when recommending investment products or strategies.

Under the proposal, a broker "must establish, maintain and enforce written policies and procedures" designed to identify, disclose and eliminate or mitigate conflicts of interest due to financial incentives.

That's a higher bar than the current broker standard, said Kevin Walsh, an attorney at Groom Law Group. Brokers are required to recommend products that are suitable to their clients, but can steer them toward those that produce a higher payout for the broker.

"Requiring that they put their customers interests ahead of their own in addition to existing suitability is a pretty big leap forward," Mr. Walsh said.

The SEC will be able to hold brokers to a higher standard because it will be able to audit their policies and procedures related to the best-interest rule, according to Lawrence Stadulis, a partner at Stradley Ronon Stevens & Young.

"The very fact of having the policies and procedures will affect the industry," Mr. Stadulis said. "If you don't have them, you're in violation of the rule. If you do have them, they have to include [the rule's] elements. Then, you're required to enforce them."

In a statement, SEC chairman Jay Clayton said "the establishment of policies and procedures to mitigate or eliminate material conflicts arising from financial incentives is perhaps the most critical enhancement over existing standards applicable to BDs; it means that BDs must do more than simply disclose their conflicts of interest."

But he was met with sharp disagreement from Democratic commissioner Kara Stein, who voted against the advice standards package and derided Regulation Best Interest as "Regulation Status Quo."

Republican commissioner Hester Peirce voted in favor of releasing the proposal package but said Regulation Best Interest was mislabeled, and should be called "suitability-plus," referring to the current rule that governs brokers' recommendations to clients.

The debate continued Thursday, as Massachusetts Secretary of the Commonwealth William Galvin criticized the SEC proposal for not subjecting brokers to a fiduciary standard, which already governs investment advisers' interactions with their clients.

"The SEC is proposing a watered-down standard that simply restates current industry rules and allows certain dangerous conflicts to persist," Mr. Galvin said in a statement. "Among other problems, the rules do not prohibit conflicted actions and will provide support for recommendations of high-cost and proprietary investment products, where conflicts have been particularly harmful to retail investors."

The proposal package — which also includes a relationship disclosure summary for advisers and brokers as well as an interpretation of the adviser standard of conduct — will be open for a 90-day public comment period after it is published in the Federal Register. It could be many months after the comment deadline before the SEC proposes a final rule package.

There likely will be conflicting feedback over the SEC's proposing Regulation Best Interest while maintaining the separate fiduciary standard for advisers, according to Brendan McGarry, a lawyer at Kaufman Dolowich & Voluck.

"There will be a good amount of argument over whether this is trying to raise the bar [for brokers] or whether this is the SEC's attempt to interpret the current [broker] standard as a best-interest standard," he said.

Much of the SEC rule falls into a gray area because the agency appeared to hurry the nearly 1,000-page proposal forward while the Labor Department is deciding whether to continue to defend its partially implement fiduciary rule in court, said Bradford Campbell, a partner at Drinker Biddle & Reath.

The DOL has until April 30 to decide whether to appeal a split decision in the 5th Circuit Court of Appeals to vacate the regulation. The SEC had an institutional imperative to release its proposal now.

"That's one of the reasons there is ambiguity in the text," Mr. Campbell, a former assistant secretary of Labor in the George W. Bush administration, said on a conference call. "You're getting a very vague initial product."

A person familiar with the SEC's rulemaking process disputed the notion that the agency moved up its release date.

"It's hard to rush a 1,000-page proposal," the person said.


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