As Fiduciary Rule Dies, SEC Seizes Investor Protection Mantle


SEC building

The Securities and Exchange Commission acted quickly to occupy the regulatory terrain left vacant by the collapse of the Labor Department’s fiduciary rule.

The package of rulemaking and interpretations proposed by the SEC on April 18 aims for a more level playing field when investment professionals recommend investments to people who act on investment recommendations primarily for personal, family, or household purposes. The SEC refers to such people as retail investors.

The package is “designed to enhance the quality and transparency of investors’ relationships with investment advisers and broker-dealers while preserving access to a variety of types of advice relationships and investment products,” the SEC said.

‘Best Interest’ Rule and More

Highlights of the proposal include a “best interest” regulation, an investment adviser interpretation, and a relationship summary provided by investment professionals to their retail investors.

Under the best interest regulation, a broker-dealer recommending a securities transaction or investment strategy involving securities to a retail customer would have to act in the customer’s best interest when the recommendation is made, “without putting the financial or other interest of the broker-dealer ahead of the retail customer.”

The best interest obligation would apply to a number of situations, including recommendations to roll over securities in retirement plans to individual retirement accounts.

A broker would discharge this duty by (1) disclosing “key facts” about the relationship, including material conflicts of interest; (2) exercising reasonable diligence, care, skill, and prudence to understand the investment product, reasonably believe it is in the customer’s best interest, and reasonably believe that a series of transactions are in the customer’s best interest; and (3) establishing, maintaining, and enforcing policies and procedures to scope out or eliminate conflicts of interest.

Broker-dealer transactions that wouldn’t per se violate the best interest standard, even if they involve conflicts of interest, include charging commissions or other transaction-based fees, receiving or providing differential compensation based on the product sold, receiving compensation from a third-party, or accepting a retail customer’s order that is contrary to the broker-dealer’s recommendation.

Advisers and Their Relationships

An investment adviser interpretation included in the regulatory package would reaffirm, and in some cases clarify, certain aspects of the fiduciary duty that an investment adviser owes to its clients under the Investment Advisers Act of 1940.

The SEC would also require that both broker-dealers and registered investment advisers file a Form CRS, which provides a client relationship summary, to outline relationship options for clients, potential conflicts of interest, and fee arrangements.

“This standardized, short form (4-page maximum) disclosure would highlight key differences in the principal types of services offered, the legal standards of conduct that apply to each, the fees a customer might pay, and certain conflicts of interest that may exist,” the SEC said.

To address confusion over the various titles used in the financial industry, the proposal bans brokers from referring to themselves as “advisors” or “advisers.” The use of those terms could mislead investors to believe that the particular firm is a registered investment adviser when it is not, according to the SEC.

The proposed rules are open for public comment until Aug. 7, 2018, 90 days following their publication in the May 9, 2018, Federal Register.

What About the DOL Fiduciary Rule?

The comments received may foretell whether the SEC proposals have smooth sailing or encounter the same kind of headwinds that eventually capsized the Labor Department’s fiduciary rule.

That rule was put on hold before taking effect and ultimately invalidated in court. It required persons giving investment advice for a fee to put their clients’ best interest ahead of their own.

The rule faced strong opposition from the start, and it was vacated in a March 15 ruling by the U.S. Court of Appeals for the Fifth Circuit. The Trump administration didn’t challenge the holding, letting an April 30 deadline pass for requesting a rehearing of the case by the full appeals court.

Although California, New Jersey, and Oregon sought to intervene in the case in order to defend the rule, the Fifth Circuit twice denied their requests for reconsideration (see California, New York, Oregon Lose Second Try on Fiduciary Rule Row).