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SEC Snuggles Up to Industry with Best Interest Rule?

By Rita Raagas De Ramos April 30, 2018

Unlike the Department of Labor’s fiduciary rule, the SEC’s proposed Regulation Best Interest package is aligned with the “business realities” that broker-dealers face daily, claims Thomas Holly, head of the U.S. asset and wealth management practice of PwC.

The biggest differentiator between the DOL rule and the proposed SEC rule is the handling of the best interest requirement – the former requires a contract and the latter doesn’t, Holly says. And this reflects the SEC’s understanding of the business models of broker-dealers and investment advisors, he notes.

The DOL rule requires retirement advisors to have their clients sign a Best Interest Contract Exemption document if there are any potential conflicts of interest in the advice they give them. The proposed SEC rule merely holds broker-dealers to a best interest standard – there are disclosure requirements but there is no requirement for clients to sign a conflict of interest contract.

That difference in the best interest requirement “sets the tone for how the SEC is approaching” the rule-making, Holly says. “There will likely be some changes but I don’t expect a significant deviation from what’s come out.”

“We were expecting a more business-friendly approach, with a lot more focus on what’s reasonable.”
Thomas Holly

The SEC staff that led the crafting of the proposed best interest rule hinted at their motivation during the watchdog’s open meeting on April 8 when commissioners voted 4-to-1 to move the proposals forward to a 90-day comment period. The staffers said they didn’t want to create the unintended consequence of significantly disrupting the business operations of broker-dealer firms because of the proposed package. The staffers also said they wanted to create a best interest standard that’s in line with investor expectations without limiting product choices.

The proposed best interest rule is just one part of the SEC's three-part package. The other two are the interpretation of the fiduciary standard for investment advisors and a new Customer Relationship Summary form that will state if clients are dealing with a broker-dealer or an investment advisor.

Holly says the industry is relieved by the proposed SEC best interest rule because it is “pretty much as predicted.”

Indeed, the proposed SEC rule mirrors suggestions put forward by Sifma to the SEC last year, when the group lobbied for a separate best interest standard for broker-dealers and one that would require a duty of loyalty, duty of care and enhanced disclosures for broker-dealers.

“We all predicted it would be a lot less onerous than the DOL rule. We were expecting a more business-friendly approach, with a lot more focus on what’s reasonable,” Holly says. Holly’s role at PwC includes oversight of broker-dealer, RIA, wealth advisory and wealth banking clients.

Holly says having a “more user-friendly” SEC best interest rule will benefit broker-dealer firms and their clients because it will not inadvertently place limitations on recommendations for investment strategies or products.

He adds that broker-dealers have already prepared for the DOL rule’s fiduciary requirements, so even if those are abandoned, investors will still receive the intended benefits of the DOL rule. In March, the U.S. Court of Appeals for the Fifth Circuit ordered the DOL to vacate the fiduciary rule in its entirety. The DOL still has a window to appeal the ruling before it becomes effective on May 7.

“Broker-dealers already adopted the DOL standards. They shrunk shelf space and changed the way they charge their clients,” Holly says. “Broker-dealers already see the benefits of a more streamlined and a more cost-effective approach to their service delivery model. It’s hard to imagine them turning their back on everything they’ve done.”

In a study commissioned by Sifma, Deloitte claimed in August last year that broker-dealers and those dually-registered as broker-dealers and RIAs already spent more than $4.7 billion to prepare for the DOL rule’s June 9, 2017 partial applicability date and would be spending more than $700 million annually to maintain compliance.

Holly says broker-dealers are reviewing the details of the proposed SEC best interest rule, such as the proposed ban on the use of the words advisor and adviser (unless they are also registered as investment advisors).

Banning the use of the words advisor and adviser is “going to require a cultural change” for broker-dealers, he says. “In that world, titles are very important; they mean a great deal.”

While broker-dealers who are also registered as investment advisors can keep their advisor title under the proposed SEC rule, they will have to clearly inform the customer whether they are acting as a broker-dealer or as an advisor when they are making a recommendation. That could lead to confusion, Holly says.

“They’re going to be required to tell their clients: ‘Today I’m a broker. Tomorrow, I’m an investment advisor’,” he says. “How will that play out and how practical is that?”

An FA-IQ straw poll shows that only 28% of the respondents are willing to give up their advisor/adviser title, while 44% want to hold on to it. Around 23% are ambivalent because they say they can use other titles anyway, such as wealth manager or financial planner. The rest don’t have an opinion.

Holly says broker-dealers are also looking at the impact of certain activities on their best interest obligations – such as sales contests.

In the proposed SEC rule, sales contests are considered “material conflicts of interest arising from financial incentives” that “may be more difficult to mitigate” and thus, “may be more appropriately avoided in their entirety.” Other examples of activities in the proposed SEC rule that are better avoided are trips, prizes and bonuses that are based on sales of certain securities or the accumulation of client assets.

Holly welcomes the inclusion of these concrete examples of conflicts of interest in the proposed SEC rule because it could potentially save millions of dollars in litigation costs if any confusion regarding these activities could be avoided.

“The SEC is aware that these types of activities go on. The fact that they are even discussing that is encouraging,” he says.

In February the Massachusetts Securities Division charged Scottrade with violating the DOL rule’s impartial conduct requirement when it held sales contests among its advisors. And the state’s top securities watchdog wants the case to stay in federal court even with the vacate order on the DOL rule.

Thomas Holly

On a broader scale, Holly says broker-dealers are evaluating if they need to augment their business and administrative processes because of the proposed SEC rule. He believes changes will indeed be needed because of the required classification of the financial professional (broker-dealer or advisor), disclosure requirements and transparency requirements.

The most tangible change is the proposed four-page customer relationship summary (CRS) that broker-dealers and their associated persons must give their clients. The CRS must make it clear to investors whether they are dealing with an investment advisor or a broker-dealer. The CRS also requires an explanation of the principal types of services offered; the legal standards of conduct that apply to the investment advisor or the broker-dealer (whichever relationship applies); the fees a client might pay; and certain conflicts of interest that may exist.