Opponents of expanding the fiduciary duty for investment advice have another weapon in their arsenal, following a court decision that chided the SEC for adopting an unrelated rule without conducting a proper cost benefit analysis.
On July 22, the U.S. Court of Appeals for the District of Columbia Circuit vacated a Securities and Exchange Commission rule that would have made it easier for shareholders to nominate company directors. Although the proxy access rule is unrelated to fiduciary duty, the court opinion echoed the case that fiduciary critics are making.
'ARBITRARILY, CAPRICIOUSLY'
“We agree with the petitioners and hold the [SEC] acted arbitrarily and capriciously for having failed once again ... adequately to assess the economic effects of a new rule,” the court opinion stated.
The court held that the SEC fell short in quantifying certain costs — or explaining why they couldn't be quantified — and didn't support the predicted benefits.
That court ruling could be used against the SEC and the Labor Department as they work to develop and expand the fiduciary standard for those giving investment advice.
The two Republican commission members dissented from an SEC staff study that recommended applying the fiduciary standard to anyone who gives investment advice. That standard, which requires that financial advisers work in their clients' best interest, is more rigorous than the standard followed now by brokers, who must make sure only that the investments they recommend are “suitable” for their clients.
The two commissioners objected to the study for failing to provide a sufficient economic justification for its conclusion, the same grounds on which the court tossed out the SEC's proxy access rule
The SEC plans to go ahead and issue a fiduciary rule this fall, but the recent court ruling should give the commission pause, according to observers.
“The D.C. Circuit case is sending them a clear warning that they need to do serious economic analysis of their rules before issuing them,” said James Angel, associate professor of finance at Georgetown University.
An advocate for widespread adoption of the fiduciary standard maintains that the proxy access case isn't a harbinger of what may come.
The benefits of fiduciary duty in terms of increasing investor returns through unbiased advice are more concrete than the positive effects of proxy access, said Knut Rostad, president and founder of the Institute for the Fiduciary Standard.
“The facts and circumstances are materially different,” Mr. Rostad said.
In their objection to the SEC fiduciary report, commission members Kathleen Casey and Troy Paredes may have been blazing a trail to the courtroom, figuratively speaking, should a final SEC rule fail to assuage critics' fears about expanding the fiduciary duty to brokers.
“The dissent from Casey and Paredes was a pretty transparent effort to provide the basis for a legal challenge,” said Barbara Roper, director of consumer protection at the Consumer Federation of America, and a supporter of universal fiduciary duty.
The SEC promises to augment a fiduciary rule proposal with a robust cost benefit analysis, though it claimed to have supported the proxy access rule with such an analysis.
The Labor Department also has said that it will provide more economic analysis for a proposed rule to extend fiduciary duty to more retirement plan advisers.
That regulation, which could be finalized by the end of the year, has drawn withering criticism from a wide range of financial industry organizations.
“The recent appellate decision doesn't change our responsibilities or our commitment to promulgating a regulation that meets our obligations to retirees and the public generally,” said a Labor Department spokesman who asked not to be identified.
There are no indications so far that either agency will be hauled into court over its fiduciary work.
“We won't even start to look at whether we want to go the litigation route until we see the final rule,” said Alice Joe, senior director of the Center for Capital Markets at the U.S. Chamber of Commerce.
“Litigation is not our preferred route,” she said. “In fact, it's our last resort.”
The chamber was one of the plaintiffs in the proxy-access case. It challenged the rule under a 1996 law that requires the SEC to take into account whether a regulation promotes “efficiency, competition and capital formation.”
The National Association of Insurance and Financial Advisors has been vociferous in urging the SEC to consider what it calls the potential deleterious effects of increased regulatory and liability costs on registered representatives. But it isn't yet considering going to court over the matter.
“That's a very remote possibility,” said NAIFA's president, Terry Headley. “But we do have to keep all viable options on the table.”
Even if the SEC isn't challenged on the cost benefit analysis surrounding fiduciary duty, constantly worrying about legal threats could undermine the commission's effectiveness, according to Ms. Roper.
SEC media relations officials didn't respond to a request for comment.
Email Mark Schoeff at [email protected]
