Brokerages unnerved by parts of SEC advice rule that echo DOL fiduciary rule

Industry lobbyist suggests regulator avoid 'prescriptive' language for mitigating conflicts.

Language in the Securities and Exchange Commission’s investment advice reform proposal that echoes the Labor Department’s fiduciary rule is drawing concern from the financial industry.

Under the SEC’s proposal, brokers would not be allowed to put their own interests ahead of their clients’ interests when making investment recommendations, and would have to establish policies and procedures to disclose and mitigate or eliminate conflicts of interest.

In its so-called Regulation Best Interest, the agency outlines steps brokers should consider taking to resolve conflicts, such as minimizing compensation incentives for certain products and eliminating sales contests, trips, prizes and other non-cash compensation.

Those directives are similar to prohibitions included in the best-interest-contract exemption of the DOL rule, which was vacated by the 5th Circuit Court of Appeals earlier this year.

“We believe the commission should replace the DOL rule-based preamble provisions on mitigation and elimination of conflicts with a simple principles-based statement,” wrote Kent Mason, partner at Davis & Harman, in a July 20 comment letter on behalf of clients including brokerage firms, insurance companies, asset managers, mutual funds and others.

Mr. Mason suggested the preamble be replaced with this language: “A broker-dealer shall establish, maintain and enforce written policies and procedures reasonably designed to ensure that financial and other incentives do not result in recommendations that are not in the best interest of retail customers.”

It’s not clear how many other industry representatives will share Mr. Mason’s concern. For instance, the Financial Services Institute, which represents independent broker-dealers and financial advisers, declined to discuss the SEC proposal until it files its own comment letter.

The comment period on the SEC proposal closes Aug. 7. Most of the comments the SEC has received so far are short statements from individual investors or market participants.

The preamble to Regulation Best Interest consumes about 400 of the proposal’s 408 pages. The rule text itself doesn’t begin until page 404.

The language admonishing brokers against certain activities is not part of the rule. The regulation does not define the term “best interest” and says the SEC will determine whether brokers violate the rule based on facts and circumstances.

(Editorial: Does the SEC really need to define ‘best interest’?)

Still, the fact that the directives are there at all is unsettling, according to Mr. Mason, because it “could be relied on by a court.”

SEC commissioner Hester Peirce cited Mr. Mason’s letter recently when she outlined her own concerns about the agency’s proposal.

“Obligations should be imposed through the rule text, not through language in the rulemaking release,” Ms. Peirce said in a July 24 speech. “Especially in an area like this in which investors and registered representatives need to know what the rules are, a lengthy rulemaking release that supplements the rule text can breed confusion.”

Mr. Mason also recommended the SEC not allow brokers to be sued over the new investment-advice standards.

“The commission should clarify that broker-dealers may include, in both their contracts and disclosures, disclaimers of contract liability based on the new commission rules and required disclosures,” he wrote.