For months, the brokerage industry has been fighting back against the Securities and Exchange Commission's effort to crack down on firms that fail to disclose to clients that they recommended high-fee mutual fund share classes — those with 12b-1 fees — when less expensive classes were available in the same fund.
The SEC's
Share Class Selection Disclosure Initiative encouraged advisory firms — most of which have brokerage operations where the problems occurred — to turn themselves in to avoid civil penalties, although they would still have to provide restitution. It has resulted in in about
$135 million in settlements with 96 firms.
Brokerage industry advocates have accused the SEC of launching enforcement on share class selection before explaining what it expected from firms on fee disclosure. Instead, they say, the agency started with enforcement.
They decry it as rulemaking — or regulation — by enforcement.
Last week, SEC member Robert Jackson Jr. said he's getting tired of that criticism. Actually, he used a more colorful term.
"I've heard the argument," Mr. Jackson said Friday at the Consumer Federation of America's Financial Services Conference. "This is bullshit. The people who are making this argument are in favor of neither regulation nor enforcement. That's cool. Just be honest."
In meetings with industry representatives, Mr. Jackson said they tell him two things. They urge the SEC not to be "prescriptive" in its rulemaking. In other words, offer flexibility to firms in how they meet an investor-protection priority. They also say "one size doesn't fit all" when it comes to regulating firms.
But they're trying to have it both ways, Mr. Jackson said.
"There's a list of five talking points," Mr. Jackson said. "What they're in favor of, I think, is fundamentally less protection in the marketplace for American investors."
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This conundrum surrounding how the SEC enforces principles-based rules may come up again with
Regulation Best Interest, the new broker investment-advice standard that is meant to be tougher than current suitability.
As critics, and even supporters of Reg BI, note, the measure does not define "best interest" nor does it spell out how brokers should mitigate conflicts of interest.
The rulemaking-by-enforcement trope "is particularly troubling in the context of Reg BI, where nothing is specifically worded, nothing is specifically prohibited," said Barbara Roper, CFA director of investor protection, who moderated a panel featuring Mr. Jackson and his fellow Democratic SEC member Allison Herren Lee.
Ms. Lee said the agency enforces a mix of principles-based rules and prescriptive rules.
"Often the folks who complain about regulation by enforcement are the same ones who push hard for these principles-based rules, and it makes you wonder whether they would ever support an enforcement of those rules," Ms. Lee said. "And they are harder to enforce, but we have to do it."
So far, the brokerage industry has expressed
support of Reg BI. But how much it strengthens investor protection ultimately will be
determined by enforcement, Mr. Jackson and Ms. Lee said.
The next time someone comes to her office to assert rulemaking by enforcement, Ms. Lee said she will be ready with a response.
"I hear those talking points, too," she said. "Now I have a talking point: 'That's bullshit.'"
