The Wall Street Journal's Jason Zweig recently complained about a study from Fidelity Investments that was interpreted to show that "Most index funds are 'below-average investments'" and that except for large U.S. stocks, in nearly every other investment category, "'Active management appears to be the better choice.'" Mr. Zweig protested, "That isn't what the study showed."
Substitute "the fiduciary standard" for "passive investing" and Reg BI for Fidelity's study, and you have what InvestmentNews reported last week when Securities and Exchange commissioner Hester Peirce said of Reg BI, "When you lay it side by side against the fiduciary standard, I think one could argue that it's a stronger standard because it does require mitigation or elimination of conflicts in a way that the fiduciary standard does not."
Ms. Peirce's remarks startled many. They shouldn't have because they're in line with prior statements of Reg BI adherents since the rule's April 18, 2018, birth.
To start, the brokerage sales activity that has been repeatedly called out for elimination is high-pressured, product-specific sales contests. This is good, of course, but for a standard called "best interest," hardly deserving of the Presidential Medal of Freedom like-accolades it gets.
The larger issue is conflict mitigation. Absent real mitigation, the rule is toothless. The proposed rule has been hailed from the mountain tops as pro-investor because it calls for mitigation. Yet, the Reg BI release text itself explicitly says it does not require any "specific conflict mitigation measures."
Instead, choice is the watchword. B-Ds get to choose their own mitigation measures and have the flexibility to "develop and tailor" their own policies. The SEC offers no clear definition of its own. Instead, it draws on Finra expertise in its October 2013 report to explain the meaning of mitigation: "The U.S. regulatory regime relies heavily on disclosure to customers as a tool to mitigate conflicts."
To underscore the SEC's meaning of mitigation, in March, after 11 months of championing mitigation as a vital and separate investor protection measure, InvestmentNews reported that SEC chairman Jay Clayton further explained that mitigation is, in fact, neither necessarily vital nor separate from disclosure after all. In fact, disclosure alone would, in his view, often be just fine.
"In some cases, disclosure is enough mitigation," Mr. Clayton said. The guiding principle would be, "What would a reasonable investor expect?"
The chairman explained that if a broker discloses that she receives a commission and tells a customer how much she is being paid, that would in his view satisfy the measure, according to InvestmentNews.
Actually, research suggests this disclosure would not satisfy an investor's reasonable expectations. It also would not satisfy the EU's MiFID II criteria.
Reg BI and Form CRS have been widely criticized by academics, adviser groups, investor advocates, investors participating in the SEC's own investor roundtables and state securities administrators for failing to meet a best interest standard — and reasonable investor expectations. The record suggests there's not a single credible, independent expert who's come forward, reviewed the proposals and explained why critics are wrong and why the B-D industry is right.
None of this record matters for Reg BI adherents, of course. The WSJ's Mr. Zweig pegged what does matter: It looks great — if you squint just right.
Knut A. Rostad is co-founder and president of the Institute for the Fiduciary Standard, a nonprofit that advances the fiduciary standard through research, education and advocacy.