By Bill Flook
Sen. Sherrod Brown, in a June 1, 2020, letter to the SEC, asked the commission to undertake “basic steps” to ensure transparent examinations and enforcement related to Regulation Best Interest (BI).
Regulation Best Interest (BI), set to go into effect at the end of the month, will put in place a series of new requirements for broker-dealers in the hopes of mitigating potential conflicts.
Brown, an Ohio Democrat and the ranking member of the Senate Banking Committee, has long criticized the SEC’s 2019 rules under Section 913 of the Dodd-Frank Act as too weak to protect investors. He and other Democratic lawmakers want broker-dealers to be subject to a far stricter fiduciary standard that requires them to put their clients’ interests first. Sec. 913 of PL111-203
“Without a clear standard that requires all financial professionals to prioritize their client’s best interests, investors will have to decipher lengthy, legalistic disclosures to understand their rights and what to expect from brokers and advisors,” he wrote in the letter.
The SEC issued the rules in Release No. 34-86031, Regulation Best Interest: The Broker-Dealer Standard of Conduct; Release No. 34-86032, Form CRS Relationship Summary; Amendments to Form ADV; Release No. IA-5248, Commission Interpretation Regarding Standard of Conduct for Investment Advisers; and Release No. IA-5249, and Commission Interpretation Regarding the Solely Incidental Prong of the Broker-Dealer Exclusion from the Definition of Investment Adviser.
Reg BI puts in place four obligations to broker-dealers. They must disclose material facts about the relationship and recommendations, including specific disclosures about the capacity in which the broker is acting, fees, the type and scope of services provided, conflicts, limitations on services and products, and whether they provide monitoring services.
Brown, despite his criticism, appeared resigned that Reg BI will go into effect as written. Brown’s letter marks a strategic shift, with his focus now on ensuring stringent enforcement of the rule, despite its perceived shortcomings.
Brown, in pushing for tough enforcement, pointed to elements of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), a $2 trillion COVID-19 relief package signed into law in late March, which waved certain penalties and restrictions on early withdrawals from tax-deferred accounts such as IRAs and 401(k)s.
A survey released by Bankrate on May 27 found that 27 percent of respondents who are working or recently lost their jobs have already withdrawn cash from retirement accounts.
“For those investors and others, the Commission’s comprehensive oversight of brokers and dealers and thorough enforcement the protections of Reg. BI will be crucial to establishing the confidence to trust the advice from investment professionals as our economy and job markets begin to recover and Americans seek financial stability,” Brown wrote.
The Ohio Democrat sought greater transparency of Reg BI enforcement on several fronts:
- tracking, categorizing, and publicly reporting data and statistics on examinations, inspection violations, and enforcement matters
- establishing metrics that would indicate “increased investor protection or outcomes over existing standards”
- identifying additional safeguards for investors should violations or investor complaints begin to spike
“These basic steps would demonstrate your commitment to protecting investors and the optimal implementation of Reg. BI,” Brown wrote.
The senator’s letter came a day before oral argument in a lawsuit seeking to invalidate the rules before they go into effect. New York, California, Connecticut, Delaware, Maine, New Mexico, Oregon, and D.C. are suing the SEC alongside XY Planning Network, an organization of financial planners working on a a fee-for-service basis, and one of its members, Ford Financial Solutions.
Arguing before a panel of Second Circuit judges, Assistant New York Solicitor General Ester Murdukhayeva asserted that the SEC – even without Dodd-Frank – was obligated to impose a fiduciary standard on broker-dealers under the Investment Advisers Act of 1940, and failed to do so with Reg BI.
Under the Advisers Act, investment advisers are subject to a far more rigorous fiduciary duty than broker-dealers. The law excludes a broker-dealer from the definition of an investment adviser if they offer advisory services that are “solely incidental” to the conduct of the broker-dealers business and collect no special compensation.
That exception is a narrow one, she said, arguing that broker-dealers are today offering more-than-incidental personalized investment advice, which means the Advisers Act imposes an independent obligation on the SEC to require a fiduciary duty Dodd-Frank, according to Murdukhayeva, “reinforces that obligation, rather than diminishes it.”
Jeffrey Alan Berger, arguing for the SEC, drove home the commission’s argument that it had the authority – but no mandate – to issue the rules under Dodd-Frank, and that invalidating Reg BI would simply bring a return to the status quo.
“If the court were to vacate Regulation Best Interest, what you have is a reversion to a suitability regime with no mandate for the commission to adopt any new rule let alone the new rule petitioners are suggesting, that would result in less investor protection,” he said.
The current suitability standard, enforced by the Financial Industry Regulatory Authority (FINRA), requires only that broker-dealers steer their clients into investments that meet their broad investment goals and appetite for risk.
This article originally appeared in the June 05, 2020 edition of Accounting & Compliance Alert, available on Checkpoint.
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