DOL and SEC Uniform Advice Standard May Not Be Far Off

In June of this year the Securities and Exchange Commission (SEC) published a request for public comment on standards of conduct applicable to investment advisers and broker/dealers when they provide investment advice to retail and retirement investors.

The request was among the first actions taken by the SEC under the new leadership of Chair Jay Clayton. President Donald Trump nominated Clayton on January, 20, 2017, but he was not confirmed by the Senate until early May. At the time, industry watchers agreed the likely style and character Clayton might bring to the commission would differ from the ostensibly aggressive approach of the Obama-era Chair, Mary Jo White.

To date Clayton has stayed relatively quiet in his new position, and it remains somewhat unclear what long-term direction the SEC is taking under President Trump. In a brief public statement delivered June 1, Clayton said he “welcomes the Department of Labor’s invitation to engage constructively as the Commission moves forward with its own examination of the standards of conduct applicable to investment advisers and broker/dealers, and related matters.”

Clayton’s comments continued, acknowledging that this work will directly intersect with the Department of Labor’s (DOL) own ongoing effort to revamp the fiduciary standard under the Employee Retirement Income Security Act (ERISA): “I believe clarity and consistency—and, in areas overseen by more than one regulatory body, coordination—are key elements of effective oversight and regulation. We should have these elements in mind as we strive to best serve the interests of our nation’s retail investors in this important area.”

In the time since Clayton made those comments, the SEC has received a small library’s worth of fresh investing industry commentary on the multifarious issue of identifying and preventing advisory industry conflicts of interest. Many of the comments mention serious discomfort with the DOL’s strengthening and expansion of its fiduciary standard, voicing a whole host of now-familiar concerns that a stricter DOL conflict of interest paradigm may unnecessarily jeopardize well-established compensation practices that have only recently become the object of scrutiny and are not in themselves problematic.

One particularly interesting and informative comment letter was submitted recently by the Financial Services Institute (FSI), which lobbies for the interests of the independent financial services community. The perspective of the FSI letter is clearly informed by the fact that its membership includes financial advisers who are technically self-employed independent contractors, rather than employees of large broker/dealers or wirehouses.

The main conclusion of the comment letter from FSI is that “any future rulemaking should build upon, and fit seamlessly within, the existing and long-standing securities regulatory regime for broker/dealers and investment advisers, while being supported by robust examination, oversight and enforcement by the SEC, FINRA and state securities regulators.” Further, FSI “agrees with Chairman Clayton that a uniform standard should be clear and comprehensible to the average investor, consistent across retirement and non-retirement assets and coordinated with other regulatory entities, including the Department of Labor and state insurance regulators.”

NEXT: Detailed arguments from FSI 

Importantly, the FSI letter is far from outright hostile to the possibility of strengthened conflict of interest rules. For example, the letter states that “FSI members believe that acting in their client’s best interest means that financial advisers shall place the interests of their client before their own; avoid material conflicts of interest when possible or obtain informed client consent to act when such conflicts cannot be reasonably avoided; and provide advice and service with skill, care and diligence based upon the information known about their client’s investment objectives, risk tolerance, financial situation and needs.”

This is exactly what the DOL leadership under President Obama said it wanted to accomplish, but FSI contends the DOL should not be taking the lead on any of this: “The SEC can integrate any future standard of care into the investor protections provided by the existing regulatory framework.” To accomplish this, FSI suggests that financial institutions and financial advisers “should be required to implement policies and procedures reasonably designed to manage material conflicts of interest; and where such conflicts cannot be avoided, to adhere to a two-tiered disclosure regime consisting of a concise disclosure document to be supplemented with more detailed disclosures posted to the financial institution’s web site.”

The full details are available in the main text of the letter, but in basic terms this approach would replace the DOL’s controversial best-interest contract exemption structure. FSI does seem to think some type of disclosure and exemption process will be necessary moving forward—but not the approach coded into the DOL fiduciary rule as it currently stands. Under FSI’s proposal, the first-tier disclosure will “serve to inform investors of the information that is most critical to their decision making at the point in time when that information is most useful and can be delivered most efficiently. Thus, these disclosures ensure that customers understand the best interest standard of care owed to them by the financial institution and the financial adviser.”

The second-tier disclosure “would provide investors with access to detailed compensation and material conflicts information via the financial institution's website or, upon request, in hard copy. The website would provide investors with detailed information concerning available investments, considerations for making investment decisions, and information explaining how a financial adviser and a financial institution receive compensation for each type of product. The disclosures would be designed to allow investors to better understand both the existence of payments to be made to the financial institution and the purposes of such payments, similar to existing revenue sharing disclosure obligations.”

Whether or not the above approach is adopted or even considered, the best interest standard “must be designed to appropriately address conflicts of interest because they may arise in any relationship where a duty of care or trust exists between two or more parties,” FSI concludes. “Indeed, being completely conflict free is not possible for financial advisers … We recommend that any SEC rulemaking require firms to develop and implement policies reasonably designed to identify, manage and mitigate conflicts. Given the complexity of the subject, the fast pace of industry innovation, and the firm-specific nature of conflicts, it is important that such a rulemaking take a principles-based approach to allow firms to tailor their policies and procedures to their unique business models.”