This article originally appeared on Advisor Perspectives by Knut Rostad
On July 9 in Boston, SEC Chairman Jay Clayton defended his June 5 broker and adviser rulemaking (Reg BI). The speech was his first attempt to address widespread criticism of these SEC actions.
Yet, instead of explaining to investors in plain language the actual meaning of the rulemaking and how it meets “reasonable investor expectations,” the chairman used most of the speech to go after critics.
He said much of that criticism is “false, misleading, misguided.” Indeed, it was so bad and so meritless that this criticism provides even more proof that the SEC got it right:
Some of this commentary has, in my view, shown a lack of understanding of the law and legal obligations of financial professionals, both before and after adoption of our rulemaking package. This has only further solidified my view that our actions were timely and appropriate, and will ultimately benefit retail investors and our markets.
His speech was a stunning attempt to dismiss out of hand critics of the rulemaking. It was a public dressing down of serious commenters from respected organizations. The AARP, Consumer Federation of America, Investment Advisers Association, CFA Institute and NASAA have all expressed serious concerns with the proposal or final rule making. Surely, they do not have a “lack of understanding” of the law.
Clayton listed seven “claims” of critics –and then tried to refute each.
The first critic’s claim is that Reg BI “will not do enough to protect retail investors.” His refutation was that Reg BI requires brokers to act in the customer’s best interest and that the BD’s interests cannot be put ahead of the customers. Also, that best interest includes obligations of disclosure, care, conflicts and compliance. Clayton affirmed that “best interest” should not be defined.
Does Reg BI substantially enhance the standard for brokers? Here are three reasons (among several) why it does not.
The Reg BI language on ‘best interest’ is from FINRA’s suitability rule. The FINRA cases cited in Reg BI state that, “A broker’s recommendation must be consistent with a customers’ best interest.” BDs and FINRA are saying their recommendations already meet a best interest standard.
This point has practical implications in a BD compliance regime. It raises a basic question. Suppose a BD recommendation is deemed consistent with a customer’s best interest under FINRA’s rules. Then, when BDs get to say what disclosure and care means, why would the same recommendation under Reg BI not also be in the client’s best interest?
Reg BI is implemented through compliance. The compliance obligation requires BDs to write and implement policies and procedures. BDs are granted substantial flexibility to set out and interpret their own policies and procedures.
But the Reg BI release boasts of BD “flexibility.” It explains, “We proposed a principles-based approach to provide flexibility to firms to develop and tailor policies and procedures that include conflict mitigation measures based on each firms circumstances, for example, the size, retail customer base, nature and significance of the conflict, and complexity of the product.”
Third, this “flexibility” delegates significant discretion to BDs. Why? Reg BI deems that, as it regards conflicts, BD flexibility beats “mandating specific mitigation measures” (see page 331 of the release) because, “broker-dealers are most capable of identifying and addressing the conflicts that may affect the obligations of their associated persons with respect to the recommendations they make.” (see page 326)
This includes deciding if mitigation is called for. Mitigation is called for only if a conflicted recommendation creates an incentive that puts the broker’s interests first – in the view of BDs. BDs are the deciders.
Reg BI does not “define” best interest. BDs will. They will write, interpret and enforce their own policies and procedures. They will do so believing they already serve customers’ best interest. They will do so with confidence because, as Reg BI asserts, “they are most capable” to do so.
Will Reg BI substantially enhance broker conduct standards? Ask your broker.
The chairman performed a public service by making the case for the 771-page Reg BI release in just a few pages. This is good. There is also a solid step that the chairman could take to follow his speech. He can, as he promised, pursue an open dialog.
Serious observers across the political spectrum offer remedies to address the infection that plagues the nation’s discourse. Those observers include some from the right, like, American Enterprise Institute’s former president Arthur Brooks and Republican Senator Ben Sasse.
The chairman’s invitation to critics to join him in an open discussion of his speech would be a concrete act that he alone can do. It would be a small step to address this infection in the industry he regulates. It would also meet investors’ reasonable expectations.
