6 big questions about the SEC advice rule

There's plenty of confusion around the contents of the agency's proposal

May 2, 2018 @ 2:36 pm

By Greg Iacurci

Broker-dealers and investment advisers have had two weeks to dissect the Securities and Exchange Commission's proposed overhaul of investment-advice standards, and some big questions have begun to emerge.

Here are some of the most pressing issues that have cropped up so far.

Is the best interest standard a fiduciary standard?

The SEC's proposal would create a "best interest" standard for brokers, meaning brokers must act in a retail client's best interests when making investment recommendations. There's a question whether this is the same as a fiduciary standard.

"The SEC is trying to add an overlay of a best-interest standard, but they don't want to call it a fiduciary standard," said Duane Thompson, a senior policy analyst at fi360 Inc. "People are asking: 'What's the difference?'"

To make it more confusing, the SEC doesn't define what it means by "best interest," attorneys said.

"The words 'best interest' are in the definition of best interest, which makes it circular," said Fred Reish, a partner at Drinker Biddle & Reath.

However, language in the rule's entirety leads Mr. Reish to believe that the SEC proposal would create a "very, very similar" broker standard to that of the DOL fiduciary rule. In fact, the SEC lifts verbatim some wording from the DOL rule's best-interest contract exemption.

"I do think it's a fiduciary standard," Mr. Reish said. "The question is: Is it the fiduciary standard people want?"

Enforcement

While the DOL fiduciary rule's best-interest-contract exemption would have created a private right of action for investors and the prospect of class-action litigation against broker-dealers, some wonder what the SEC's enforcement mechanism would be.

"I think the big question is: How is enforcement going to be effectuated?" said Marcia Wagner, principal at The Wagner Law Group. "Under the SEC there really is nothing — just the same old, same old, with mandatory Finra arbitration," she added.

Interestingly, enforcement plays into the first question around the definition of "best interest." If enforcement plays out largely in private Finra arbitrations, "any nuances important in a customer dispute will be lost," Mr. Thompson said.

In other words, Finra's interpretation of "best interest" will not be public.

Conflict mitigation

An important element of the best-interest standard is conflict mitigation. Part of this entails broker-dealers setting (and enforcing) policies and procedures to "disclose and mitigate," or eliminate, conflicts of interest arising from any financial incentives.

Because outright elimination of conflicts would be challenging, mitigation becomes the big question here, attorneys said.

"How much do you have to mitigate?" Mr. Reish said. "That word 'mitigate' hasn't received a lot of publicity yet. But I guarantee over the next couple months you'll hear more and more about mitigation."

The SEC gives examples as to how a firm may go about mitigating conflicts but leaves flexibility for broker-dealers to develop their own methods. One example: making compensation level across similar product lines.

'Unconscious' conflict of interest

The SEC interprets a "material conflict of interest" as a conflict that "a reasonable person would expect might incline a broker-dealer — consciously or unconsciously — to make a recommendation that is not disinterested."

But, just what is an "unconscious" influence on a decision?

"It's confusing," said Kevin Walsh, an attorney at Groom Law Group, who added that it's not intuitive.

Definition of 'recommendation'

The best-interest standard for brokers would apply to brokers making an investment "recommendation." The SEC, in its rule, initially proposes using Finra's definition of "recommendation" in order to "provide clarity" for broker-dealers and "maintain efficiencies."

However, the SEC has hinted that may not use that definition. The SEC "indicates it may develop its own interpretations down the road," said Susan Grafton, a partner at Dechert.

"This raises questions about whether Finra will still be able to interpret its own rules, and suggests the possibility of divergent definitions of the same term in the future," Ms. Grafton said.

Cost benefit analysis

The SEC's cost benefit analysis of Regulation Best Interest — which creates the best-interest standard — assumes the DOL fiduciary rule is still in place.

The analysis relies on costs broker-dealers incurred from the DOL rule to show that taking additional compliance measures would not be particularly burdensome, Mr. Walsh said. However, if the DOL rule goes away — a scenario that appears likely at this point — would the SEC update its cost benefit analysis, Mr. Walsh asked.

If so, that could "reframe" the SEC's proposal; broker-dealers may like the SEC rule less if it appears to be more costly for them to implement.

0
Comments

What do you think?

View comments

Recommended for you

RIA Data Center

Use InvestmentNews' RIA Data Center to filter and find key information on over 1,400 fee-only registered investment advisory firms.

Rank RIAs by

B-D Data Center

Use InvestmentNews' B-D Data Center to find exclusive information and intelligence about the independent broker-dealer industry.

Rank Broker-dealers by

Featured video

INTV

How InvestmentNews picks its Women to Watch winners

The process is laborious and exacting, but well worth it. The end result each year is an impressive group of women in the advice industry from whom others can draw inspiration.

Latest news & opinion

Some good news about female recruitment in financial advice

Each of four core advisory positions tracked in InvestmentNews' benchmarking study has seen an uptick in women entrants.

10 ETFs that are up more than 35% this year

Amid the stock market carnage, there are still some funds posting big gains.

10 biggest HSA providers rated

Morningstar rated the largest plan providers as investment and spending vehicles.

Morningstar: DOL fiduciary rule reduces inflows to mutual funds with high loads

With the measure's demise, will the SEC's advice reform sustain the momentum?

6 tax strategies for year-end planning

How to help clients maximize their wealth using specific tax strategies before the end of the year.

X

Hi! Glad you're here and we hope you like all the great work we do here at InvestmentNews. But what we do is expensive and is funded in part by our sponsors. So won't you show our sponsors a little love by whitelisting investmentnews.com? It'll help us continue to serve you.

Yes, show me how to whitelist investmentnews.com

Ad blocker detected. Please whitelist us or give premium a try.

X

Subscribe and Save 60%

Premium Access
Print + Digital

Learn more
Subscribe to Print