SEC Brings Increased Confusion For Investors With New ‘Best Interest’ Rule

Text sign showing Fiduciary Duty. Conceptual photo A legal obligation to act in the best interest of other.

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An almost decade-long discussion to further consumer protections took a step today, but not necessarily a step forward. The SEC commissioners voted on June 5 to push forward a final rule aimed at expanding and clarifying the roles of a fiduciary advisor and that of a broker. While some will say this new rule pushed forward the fiduciary standard, it could be setting the stage for even more consumer confusion and a watering down of the highest legal standard of care across financial services.

7 Key Takeaways from the SEC Rule

  1. Brokers required to adhere to a soft “best interest” standard
  2. Sets up DOL to synchronize rule-making later this year
  3. Big win for brokers and large financial services
  4. CRS form likely to add to client confusion in deciding on broker v. fiduciary advisor
  5. More focused on protecting brokerage role than consumer
  6. Rule lacks enforcement and teeth to hold brokers to standard
  7. Final rule still missing clear guidance on what is best interest or incidental advice

Back in 2010, just coming out of the great recession, the Dodd-Frank Act was passed in an effort to regulate financial services in the aftermath of the financial crisis. Section 913 of the Dodd-Frank Act authorized the Securities and Exchange Commission (SEC) to adopt a fiduciary duty and a best interest standard of conduct rule for investment advisors, brokers and dealers when engaging in personalized investment advice. The new final rule from the SEC is the culmination of this decade-long process.

On June 5, 2019, during the SEC hearing on the rule proposals, SEC Chairman Jay Clayton acknowledged the long delay, noting that the delay didn’t make the rule making easier, but actually harder.

Generally, the financial planning world can be broken very simply into two categories:

  1. Those that sell products (the broker-dealer model) and
  2. Those that engage in investment and financial planning advice (the advisor model).

Generally speaking, SEC investment advisors are held to a fiduciary standard and others are held to a suitability standard. It’s not that one is good and one is bad. Both are important and crucial to the current financial system here in the U.S. However, the issue lies in consumer awareness and understanding. The problem is these are two different models of advice that consumers struggle to differentiate between. Additionally, the broker model has often been criticized for failing to place consumer interests before that of the broker.

The final rule’s package of items basically contains four main parts.

  1. Regulation Best Interest – This is the centerpiece, requiring brokers to act in a client’s “best interest.” The meat of this is being done through disclosure of conflicts and a somewhat light requirement to mitigate conflicts. However, it is not clear how mitigation will exactly work and if behavior will change much from the current suitability model. Broker-dealers would have to begin complying with this by June 30, 2020.
  2. Form CRS – This piece lays out the relationship between the client and the broker or advisor and distinguishes to some degree between the two groups of potential ways you can get investment advice. According to the SEC’s June 5 meeting, this document would need to be delivered to clients at the beginning of a relationship. This would lay out potential conflicts, their legal standard of conduct, fees, services, and other important information relating to the client relationship.
  3. RIA Standard of Conduct – The rule also further interprets the standard of conduct surrounding Registered Investment Advisor firms currently acting as fiduciaries.
  4. “Solely incidental” – Lastly, the SEC sought to further clarify and interpret the meaning of investment advice that is “solely incidental” to their business.

From a top-line perspective, SEC-registered investment advisors have been held to a fiduciary standard of care when providing investment advice, while broker-dealers are being held to a “suitability” standard of care. The SEC’s rule-making processes was designed to bring clarity to this situation and essentially expand out this higher standard of care to everyone providing covered investment advice. However, the SEC Commissioner made it clear on June 5, that this rule is not aimed to create an across the board standard of care or model. Instead, he noted that doing so would be dangerous. As such, it is clear that while the “best interest” regulation brings some elements of a fiduciary standard, it does stop well short even according the SEC itself.

So, What Really Happened?

In short, the SEC rolled out their final rule, a conversation which began years ago with the intended goal of expanding and clarifying the broker’s role in providing investment advice. It’s perfectly logical to expect that the end result of such a conversation would be further consumer protections and tightened regulations for financial services.

Not so fast.

Big business and brokers can breathe a sigh of relief after hearing the final decision. Not only does this rule fail to expand consumer protections and add clarity to the broker vs. advisor roles, it allows brokers to continue business as usual by adding confusion to the market.

Where the SEC Rule Fails

First, instead of requiring a fiduciary standard of care across the board for anyone engaging in investment advice, broker-dealers can continue to adhere only to “best interest” standard. In addition, this rule presented a perfect opportunity to firm up what “best interest” means, but the SEC declined to do so.

I have mixed feelings about this, because best interest can vary from client to client, and this allows flexibility when needed. However, the grey area has proven to be problematic, because, as you can imagine, it’s hard to hold someone accountable to a flexible and unclear standard of care.

Two other areas that sorely needed additional consumer protections but were left untouched are the rules around mitigation of conflicts of interest and the specific broker sales practices. The SEC fact sheet delivered on June 5 did take positive steps from the proposed rule but still left significant worries. For instance, sales competitions with award trips, bonuses and other rewards tend to prioritize growth over customer care (think Wells Fargo) were to some degree shot down in the rule, but not entirely. While specific product sales leading to bonuses appear to be shot down, an overall competition or bonus system for selling a suite of products is not clearly prohibited. This could really just cause companies to redo their bonus and competition models and allow them to continue.

The issue with not banning certain harmful practices is that consumers have to be on the lookout for them, but we rarely know what’s going on behind the scenes. No broker ever says, “This product is part of a sales competition in the office, so it would really help get me one step closer to that trip to Jamaica if you bought it.”

It’s nearly impossible for a consumer to enforce this aspect of their relationship. Honestly, if sales people had to read a disclosure like that out loud and provide it in writing on a single page, it might have some impact (although disclosures typically have little if any impact).

Now What About The DOL Rule?

The rules now apparently, according to the June 5 meeting, do apply to recommendations from rollovers and IRAs. This clears up a big piece of confusion after the proposed rules were originally released. However, this does put the Department of Labor on notice. The DOL fiduciary rule had a lot more teeth to the bill and expanded the fiduciary and best interest model out to those acting in a brokerage capacity. In addition, in their attempt to require a signed best interest contract, which allowed for litigation and class action lawsuits, really put teeth into the enforcement of the standard.

If the DOL fiduciary rule had teeth, this new SEC rule just has gums. It lacks any enforcement muscle and will likely allow most brokers to maintain the status quo.

Perhaps further complicating matters is the fact that DOL head Alexander Acosta recently said the government is working on something related to the DOL’s fiduciary standard. While the Obama Administration’s DOL really pushed for consumer advocacy, the current DOL abandoned let the previous rule die in court and suggested a more pro-business position.

Rather than defending or proposing an expansion of the fiduciary standard of care, the DOL could very well be moving toward creating a new prohibited transaction exemption for brokers to align with the SEC rule. In concept, this makes a lot of sense. Pretty much everyone agrees that the SEC and DOL should align their rules and regulations to increase consistency and avoid potential regulatory conflicts.

However, if the DOL adopts a new prohibited transaction rule for brokers adhering to the SEC’s “best interest” rule, it will free up brokers to advise on 401(k)s, IRAs and other retirement accounts without taking on additional liability or a higher standard of care. Rollovers would be ripe to be pitched proprietary products – all without being a prohibited transaction or having to meet a fiduciary obligation.

The New CRS Says Broker=Advisor

The SEC also rolled out a new CRS – Client Relationship Summary form. The CRS form was originally designed to help consumers make more informed decisions about investments accounts and services, as well as help them distinguish between investment advisors and brokers.

The problem with this approach is that it puts brokers and investment advisors on the same page. By comparing them – and including SEC language stating that you can get investment advice from either an investment advisor or a broker (see page 7 here) – it essentially makes them the same in a consumer’s mind.

You want to be compared to your competition. As such, we have seen a lot of support from brokers on the new form and pushback from fiduciary supporters. This gives you the notion it might not be meeting its intended goals.

Of course, the form was tested. Consumers approved and even said it would help their decision-making. And the iTunes user agreement could be pretty informative too, if anyone actually read it.

Two separate studies showed that consumers who read the form still failed to grasp what it said and didn’t appear to gain any understanding of the differences between the type of professional they could hire. If anything, this form might have the opposite impact of its intended goals.

The requirement to use this form could be ripe for litigation and challenges citing protection of free speech in the First Amendment. In fact, the DOL rule was challenged in part under free speech too, although it is not why the rule eventually faltered in court.

However, with the CRS form, the requirement to say that brokers can provide investment advice could be seen as a violation of free speech for a Registered Investment Advisor meeting a fiduciary standard, as the fiduciary might honestly believe that a broker cannot provide such advice. Being forced to otherwise provide this information to clients could be viewed as a violation of their free speech.

Without a doubt, litigation will be filed to challenge the SEC rule. We will likely see challenges from both sides: the broker world and the investment advisory world. The broker world could seek to push back some of the regulations, while the advisory world could push back on the fact that this rule basically erases the distinction between advisor and broker.

In the end, the rule could be seen as a step forward or it could be seen as proving sheep clothing to wolves. Either way, consumers still need to be proactive and take charge of vetting the advice they are receiving. Any time you are getting financial advice, make sure you inquire with the advisor about what is important to you. Consider the three questions below when looking for financial and investment advice.

3 Key Questions Consumers Should Ask Their Financial Services Professional

  • Are you a fiduciary? (Get the answer in writing). This will be even more important after today’s ruling – and don’t be swayed by a “yes, we act in your best interest” verbal answer. Get them to put in writing that they act as a fiduciary. The difference might sound minor, but it’s far from it.
  • What is your financial services education? Look for serious education from the person. Designations like the CFP®, CFA®, and ChFC® are often viewed as some of best financial planning and investment education standards for advisors. If you really want a fiduciary, look for a CFP®. The CFP® professional can be held to a fiduciary standard for broad based planning by holding themselves out as CFP®. They also go through education requirements that other advisors do not. 
  • How are you compensated? Not every compensation model is the same. There is not a “good” or “bad” compensation model across the board – it just needs to fit your situation, but you should be informed. A lot of times you will be given documentation or disclosures on compensation, but you must also ask about it and get a clear answer.

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