On April 18, the Securities and Exchange Commission released its much-anticipated "fiduciary" rule proposal, "designed to enhance the quality and transparency of investors' relationships with investment advisers and broker-dealers while preserving access to a variety of types of relationships and investment products."
The realities of the rulemaking process, substantive aspects of the proposal and surprisingly negative comments from most of the commissioners all suggest that the proposal will face a long and arduous journey forward.
The path to implementation of the SEC advice rule starts with a 90-day public comment period ending in late July. Following that, the SEC will evaluate the comments, make refinements (if not wholesale changes) and release a revised version that will almost certainly undergo at least one additional round of comments and subsequent revisions. If the DOL fiduciary rule's past is prologue for the future of the SEC's rule, court challenges could prolong the process.
Under a fast-track scenario of only two rounds of public comments and no court challenges, a rule could conceivably be finalized by the end of 2019. There would almost certainly be a transition period of at least one year before the rule would become effective, thereby stretching the schedule into 2020 — and that's the best-case scenario.
The centerpiece of the proposal is a new Regulation Best Interest rule. The headline for this part is that the long-contemplated notion of an SEC uniform fiduciary rule didn't materialize. The new standard is not fiduciary and isn't uniform; arguably, it isn't even best interest in the classic sense.
ERISA and the Advisers Act of 1940 frame "best interest" in a fiduciary context grounded in well-established common law. The SEC's new version of "best interest" references fiduciary principles, but is described as "building upon, and being tailored to, the unique structure and characteristics of the broker-dealer relationship with retail customers and existing regulatory obligations."
Commissioner Hester Pierce objected to the characterization of the standard as best interest, saying: "It would be better to acknowledge that we are proposing a suitability-plus standard and explain what we mean by the 'plus.'" Commissioner Kara Stein was more direct: "Calling it Regulation Best Interest is not just confusing, it is in effect a form of mislabeling."
Regardless of the title, the rule would raise the bar for broker conduct by placing tighter controls on conflicts of interest and requiring more thorough vetting of the products that brokers recommend to clients. The existing fiduciary standard for investment advisers would remain in place. The distance between the two standards is narrowed, but the lines of demarcation remain unclear.
The SEC acknowledges investor confusion about differences in roles and standards and seeks to tackle that problem through the second major rule of the proposal, which introduces a new disclosure document, the client relationship summary (CRS), and prohibits brokers from using a title containing the word "advisor" or "adviser" unless they register as an investment adviser with the SEC.
Form CRS is to be a brief (no more than four-page) disclosure document used by brokers, advisers and dually registered persons to describe the nature of the client relationship, the applicable standard of conduct, costs and forms of compensation inherent to the relationship and material conflicts of interest, among other things.
Unfortunately, the new form CRS doesn't cut through the confusion. Rather than differentiating the sales orientation of brokerage activities from the investment adviser's obligation to provide objective advice, Form CRS tries to parse the degrees of advice involved in each type of client relationship. This skirts the fundamental reason why different standards exist and obscures how investor protections differ under each.
Ironically, the 5th Circuit Court of Appeals decision to vacate the Labor Department's fiduciary rule was focused on the differences between sales and advice, and laced with criticism of the DOL for improperly dragging brokerage and insurance salespeople under a fiduciary standard. It even noted that if salespeople misrepresent themselves as advisers, title regulation would be a preferred course of action. The title protection part of the SEC's proposal attempts to do just that; however, in its current form, the proposal allows dual registrants to call themselves advisers even in circumstances when they are providing only brokerage services. That's a loophole that will need to be closed.
Ultimately, the SEC proposal has the potential to "enhance the quality and transparency of investors' relationships with investment advisers and broker-dealers" as it was designed to do, but it will take enormous time and effort to get there. In the words of Commissioner Robert Jackson Jr., "the problems with the proposal are too many to list."
As regulatory standards rise and fall, the high ground of fiduciary conduct is the safest place for advisers to be. Once there, there is no reason to turn back.
Blaine F. Aikin is executive chairman of fi360 Inc.