The NeverEnding Story—Reg BI and the Latest Fiduciary Folly

Progress on the fiduciary rule has often looked like two steps forward, one step back  (or vice versa).

Now, we’re taking a giant step to the side.

The Department of Labor (DOL) scheduled the implementation of the fiduciary rule to begin in April 2017, with a phasing-in period until January 2018.

Then, after President Trump requested a review of the rule, the deadline was pushed back to July 2019.

“The DOL fiduciary rule was already in purgatory when we rung in 2018,” George Michael Gerstein, Fiduciary Governance Group co-chair in law firm Stradley Ronon’s Washington D.C. office, explains. “While it was clear the rule was unlikely to survive in its Obama-era form, the question was more over whether a scalpel or wrecking ball would be the preferred instrument, and whether it would be at the hands of Trump’s DOL or a court.”

It was better described as a kill shot, with the 5th Circuit Court of Appeals taking aim and vacating the rule, which had some in the industry cheering, and others lamenting the loss of a chance to level the fiduciary playing field.

The SEC has since tried to fill the void with its “advice rule,” known as Regulation Best Interest—or Reg BI—originally proposed in April 2018 and set to be finalized in the coming months.

It announced Reg BI will ensure “broker-dealer(s) would be required to act in the best interest of a retail customer when making a recommendation of any securities transaction or investment strategy involving securities to a retail customer.”

However, this standard would not apply when a broker-dealer is implementing recommendations when acting as an investment advisor in a dual registered B/D-RIA firm.

Industry expert Michael Kitces, author of The Kitces Report and Nerd’s Eye View, plainly lays out what the proposed regulation does–and does not–accomplish:

• Regulation Best Interest would require brokers making a recommendation to a retail customer to act “in the best interests of the retail customer at the time the recommendation is made, without putting the financial or other interest of the broker-dealer ahead of the retail customer” though without imposing a full fiduciary duty on brokers.
• RIA Harmonization and Fiduciary Formalization would potentially add a requirement for investment advisor representatives of RIAs to get ongoing Continuing Education credit, introduce a minimum net worth or capital requirement to operate an (SEC-registered) investment advisory firm, and require RIAs to better affirm that clients are receiving regular quarterly advisory account statements.
• Disclosure Form CRS would be a new standardized short-form (four-page) disclosure that all broker-dealers and investment advisors would be required to provide to clients (in addition to other existing broker-dealer and RIA disclosures), providing a “relationship summary” of the key points of the relationship, including the services to be provided, the fees and other costs that may be incurred, and the standard of care that the advisor would be subject to.
• Advisor/Adviser Title Reform that would limit brokers at standalone broker-dealers (but not hybrid broker-dealers) from using any title that includes the word “advisor” or “adviser,” as an extension of the requirement for updated and more accurate disclosures under the Form CRS proposal.

But according to Kitces, “introducing a ‘Regulation Best Interest’ may be so on-the-nose that consumers will actually just be more confused about the difference between a non-fiduciary ‘Best Interests’ standard for brokers and a ‘fiduciary’ standard for RIAs that requires them to act in the client’s best interests.”

He adds that “by exempting dual-registered brokers from both the obligations of title reform, and Regulation Best Interest itself, it’s not entirely clear if the SEC is really aiming to clarify the differences between brokers and investment advisers …or to simply induce all broker-dealers to launch corporate RIAs as a safe harbor for their advice-related activities to avoid ever really facing greater scrutiny of the broker-dealer model and how their advice is implemented in the first place.”

Reg BI generates collective yawn from fiduciary community

Unsurprisingly, fiduciary experts and advocates are not impressed with Reg BI.

“It doesn’t go far enough,” says Blaine Aikin, executive chairman of Fi360 and CEFEX (Centre for Fiduciary Excellence), and roundly seen as one of the leaders of the fiduciary standard movement.

“It’s important to recognize that Reg BI is much less than a fiduciary rule. While it has fiduciary-like principles embedded, the proposed best interest rule falls well short of a full fiduciary standard.”

Kathleen McBride, AIFA, AIF, is more blunt.

“The safe harbor in Reg BI codifies practices that are not good for investors and makes it even more confusing for them,” says the founder of FiduciaryPath, who is also a CEFEX analyst. “It completely eviscerates the good that the rule could have done.”

Calling it “progress at a cost,” Aikin adds that there are degrees of unhappiness.

“Reg BI doesn’t extend true fiduciary accountability to all those who provide advice, but it does set a higher bar for broker-dealers than what exists today and establishes stronger obligations to manage costs and conflicts.

“Perhaps the biggest failing of Reg BI is that it adds to consumer confusion rather than reduces it. The fiduciary standard is a true best interest standard, Reg BI is really a heightened suitability standard and the SEC’s proposal does little to make the considerable difference between the two standards clear.”

Former SEC economists attack their own

“Extraordinary” and “I’ve never seen anything like it,” are how Aikin and McBride, respectively, describe the formal comments by 11 former SEC economists on Reg BI that were released in February 2019.

The group says that the SEC’s economic analysis of Reg BI is “weak and incomplete” and that it “seems to fall short of the best attainable analysis and we are concerned about the commission’s reputation for doing careful economic policy analysis.”

To have former career officials weighing in so harshly on Reg BI puts the SEC between a rock and hard place, says Aikin.

“The SEC wants to finalize Reg BI, but what they’ve introduced is flawed in a number of ways. If they respond to criticism and make significant changes from the April 2018 proposal, they’d be required to go out for public comment again,” adding that he thinks it could also be vulnerable to legal challenges.

Citing the potential for consumer confusion as a result of Reg BI, the former officials note that the economic analysis’s “discussion of potential problems in the customer-advisor relationship (is) incomplete” and they “identify several features of the market for ongoing retail investment advice that might be considered problematic.”

McBride notes that though she is not a “regulation hound,” a rule that could lead to consumer confusion is “just plain wrong.”

Regarding an era of deregulation for deregulation’s sake, she adds, “You can’t take the seatbelts off the investors and then throw them into a convertible.”

Industry response to Reg BI is mixed

Stradley Ronon’s Gerstein calls the industry response to Reg BI “nuanced.”

“Reg BI comes in the wake of the DOL rule, which caused heartburn in terms of industry compliance for many,” says Gerstein.

He notes that many investment advisors are in a “state of purgatory” because they see the marketing benefit of the previous DOL rule but if policies were changed to adhere to it, and you don’t execute on those points to the letter, you could find yourself in legal trouble.

Some see Reg BI as a win for broker/dealers and insurance groups, whose lobbying dwarfed the interests of consumer-focused groups.

Notes Gerstein, there was general support amongst commenters that the SEC’s proposals were well-intentioned, and that the SEC should continue to take a lead on formulating a best interest standard for broker-dealers.

“However, many commenters felt the SEC’s proposal was vague and went far beyond current broker-dealer obligations.

Many hoped the final rules would show significant improvements over the proposals.”

Additionally, he adds, the attorneys general of New York, California, Connecticut, Delaware, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New Mexico, Oregon, Pennsylvania, Rhode Island, Vermont, Washington and the District of Columbia submitted a letter during the SEC’s official Reg BI comment period calling for a uniform fiduciary standard and, inter alia, for Regulation Best Interest to “require the elimination of certain conflicted compensation incentives that cannot be sufficiently mitigated and to base any differential compensation to individuals on neutral factors.”

States look to fill the fiduciary void

Some states are making fiduciary noise of another kind.

Regulators and legislators in New Jersey, New York, Nevada and Maryland, and others, are looking to fill a perceived void created by the absence of the DOL fiduciary rule, and the perceived lacking of the SEC’s proposed Regulation BI.

Gerstein has been watching the proposals, including New Jersey’s, which is currently soliciting comments as to whether it will pursue adopting rule amendments that would require broker-dealers, agents, investment advisors and investment advisor representatives to be subject to an express fiduciary duty.

McBride testified on behalf of the New Jersey proposal and says the various state initiatives have the potential to do good.

“It’ll be very interesting to see what happens. Fiduciary rule opposition groups, including SIFMA, may eventually wish the DOL rule had gone through because now they have to react to each state on a case-by-case basis,” noting that the broker/dealer advocacy group threatened litigation in New Jersey after the state announced its proposal.

Since the SEC Reg BI has been well-received by hardly anyone, Aikin sees the state movement as more than a flash in the pan.

“We will continue to see states pushing initiatives, especially if the federal government can’t issue guidance to adequately protect the consumer.”

But despite the best intentions of the initial state proposals, Aikin calls the approach problematic from a practical aspect. Gerstein agrees, adding that opponents feel that a patchwork approach is inefficient and could raise consumer costs.

It also appears that most states are waiting to see the final SEC Reg BI and then taking steps from there to shore up any gaps. But, “you have to give the states credit for moving the ball along when the federal outlook is so uncertain,” summarizes Aikin.

Rule uncertainty leads to advisor uncertainty

Most importantly, how has the regulatory uncertainty affected advisors, and what should they be doing as they await the SEC proposal?

“It’s a game of patience,” Gerstein says, and advisors should be mindful to watch how it unfolds and to stay on top of every development. “The dust hasn’t settled on either the federal or state level in order to change the way you practice.”

However, Aikin paints the picture like this: imagine the distribution of financial services practitioners on a bell curve, with thin tails at the end and a big bubble in the middle.

The left-hand tail are those advisors who are not meeting fiduciary standards, or are non-compliant and may be in regulatory trouble. Clearly, you don’t want to be in that group, Aikin says matter-of-factly.

In the main part of the bubble are the advisors who are doing a good job and are compliant.

It’s the right side of the bell curve where advisors are on the cutting edge of ethical and competent advice.

“Where do you want to be as an advisor?” Aikin rhetorically asks. “Think less about what any future law or regulation requires but instead, how to have sound procedures and policies in place so that you can be exceptional in the fiduciary marketplace.”

Lynn Brackpool Giles is former Managing Director of Communications and Consumer Services for the Financial Planning Association (FPA). In this senior management role, she oversaw all corporate and strategic communications, media relations, legislative communications and consumer affairs for the national association.