Last week, the SEC issued proposed rules governing broker-dealer and investment advisor conduct. The rules serve as a counterpoint to the fiduciary rules issued by the Department of Labor.
The SEC proposal runs over a thousand pages. Although it is not feasible to provide a comprehensive summary of such a wide-ranging promulgation, we outline some high-level concepts below.
1. The SEC and DOL rules are markedly different. The DOL rule is in part a substantiverule, prescribing the types of products that may be offered and the fees that an FA may receive. The SEC rule is in essence a procedural (process oriented) rule, allowing access to all investment products and fees but requiring enhanced disclosure.
2. Although Dodd-Frank gave the SEC authority to establish a unified standard of care for broker-dealers (BDs) and investment advisers (IAs), the proposal maintains separate rules for the two groups. The bulk of the proposal sets out a new standard applicable to BDs, while reaffirming the fiduciary standard applicable to IAs.
3. Under the proposal, a BD must act in the “best interest” of its customers at the time a recommendation is made, and may not put its financial interests ahead of the interests of the customer.
a. The “best interest” standard is a stronger standard than the current suitability standard, but less stringent than the DOL fiduciary standard. The SEC professed concern that the DOL rule, with its preference for fee-based systems, limited the products and services that BDs could provide, and in some cases (such as for smaller buy-and-hold investors) resulted in reduced services or higher fees. Unlike the DOL rule, which envisions disputes settled by private class action litigation, the SEC proposal would have disputes handled by arbitration.
4. The SEC proposal does not define “best interest”, but it makes clear that a BD meets the standard by doing the following:
a. Disclosure: Brokers must disclose key facts about the scope and terms of the relationship with the client, including material conflicts of interest, such as bonuses or fees for selling specific products.
b. Care: Brokers must exercise "reasonable diligence" to understand the product and have a "reasonable basis" to believe the product is in the customer’s best interest based on the customer’s investment profile and the potential risks and rewards associated with the recommendation.
c. Conflict of interest: BDs must establish and enforce policies and procedures "reasonably designed to identify and then at a minimum to disclose and mitigate, or eliminate, material conflicts of interest arising from financial incentives.”
i. Note that, unlike the DOL rule, the SEC proposal does not require BDs to eliminate conflicts of interest entirely. Disclosure and mitigation of those conflicts is sufficient.
5. To avoid confusion, the proposed rule prohibits brokers from describing themselves as “advisors”, reserving that term for IAs.
6. Brokers and IAs are required to provide a “client relationship summary” (CRS) that discloses the nature of the client relationship, the applicable standard of conduct, the fees the client would pay, and material conflicts of interest. The SEC provides samples of the CRS for brokers, IAs, and combined BDs / IAs.
Andrew H. Friedman is the founder and principal of The Washington Update LLC and a former senior partner in a Washington, D.C. law firm. He and his colleague Jeff Bush speak regularly on legislative and regulatory developments and trends affecting investment, insurance, and retirement products. They may be reached at www.TheWashingtonUpdate.com.
The authors of this paper are not providing legal or tax advice as to the matters discussed herein. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. It is not intended as legal or tax advice and individuals may not rely upon it (including for purposes of avoiding tax penalties imposed by the IRS or state and local tax authorities). Individuals should consult their own legal and tax counsel as to matters discussed herein and before entering into any estate planning, trust, investment, retirement, or insurance arrangement.
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Copyright Andrew H. Friedman 2018. Reprinted by permission. All rights reserved. |
