FSI vows to monitor Reg BI ‘regulation by enforcement’

The Financial Services Institute is worried about how the agency might expand Reg BI's reach. The problem is tied to setting new disclosure standards through enforcement initiative, rather than doing so through rulemaking.

A trade association that led the effort to label the SEC’s crackdown on inadequate disclosures of mutual fund fees as “regulation by enforcement” is vowing to monitor the agency’s approach to enforcing Regulation Best Interest.

The Financial Services Institute, which represents independent broker-dealers and financial advisers, was one of the most vocal critics of the Securities and Exchange Commission’s initiative to target firms that recommended high-fee funds — those that charged 12b-1 fees kept by firms — in advisory accounts without telling their clients that less expensive share classes were available in the same fund.

The problem, the organization asserted, was that the SEC set a new disclosure standard through its enforcement initiative rather than doing so through rulemaking, a process it called regulation by enforcement.

FSI is now concerned that the SEC will follow a similar path on Reg BI, the broker investment advice standard that went into force last June.

In an appearance at an online hearing of the House Financial Services Committee last month, SEC Chairman Gary Gensler said the agency will work “through examinations and enforcement [and] guidance to ensure that that rule is fully complied with as written” and “update and freshen” the measure as needed.

That perked up FSI’s ears.

“We do expect to see some changes [to Reg BI] and for that to happen through examinations and enforcement and guidance to expand the regulatory expectations,” FSI executive vice president and general counsel David Bellaire said in an on-demand session of the BNY Mellon Pershing Insite conference.

Bellaire said FSI will pushback if it sees what it considers to be new Reg BI regulations by enforcement.

“That’s a model I think we are worried about seeing repeated in the Regulation Best Interest context,” Bellaire said. “We’re going to be paying a lot of attention to the SEC and Finra and their examination and enforcement activity around Regulation Best Interest … [and] approaching the SEC for guidance when it’s appropriate and raising concerns about regulation by enforcement whenever we see evidence of it.”

In its share-class-selection enforcement initiative, the SEC returned more than $139 million to investors. The agency allowed firms to avoid civil penalties if they reported their own violations. The agency is continuing to file cases but no longer offering the civil-penalty concession.

SEC enforcement staff defended the effort, saying disclosure of 12b-1 fees is part of the fiduciary duty that governs advisory accounts. Former Commissioner Robert Jackson Jr. used an expletive to describe industry criticism of the share-class initiative and asserted brokerages were simply trying to avoid regulation.

Enforcing Reg BI could cause controversy as the rule — which prohibits brokers from putting their own interests ahead of their customers’ interests — addresses lucrative, but potentially conflicted, practices such as financial advisers receiving third-party payments.

Joan Schwartz, chief legal officer at BNY Mellon Pershing, said there hasn’t been “a ton of clarity” from regulators about Reg BI expectations.

“Firms will be anxiously awaiting this and looking forward to see not only Chairman Gensler’s opinion on this but what key members of his staff will bring to the table,” Schwartz said during the session.