Yesterday, the SEC posted notice of an open meeting on June 5 in Washington, DC to consider new rules that have been the subject of intense and controversial debate for two decades. The Commission is expected to issue final rules on Regulation Best Interest, Form Customer Relationship Summary, and an interpretation of the Investment Advisers Act fiduciary duty.
At the Core of the Debate
At the core of this longstanding debate is what standard of care should apply to brokers who provide investment advice to retail customers. Under current law, brokers are subject to a so-called “suitability” standard that means they must provide advice that is merely suitable to their client’s situation. Under proposed Reg BI, the standard would be higher, more rigorous, and more stringent – requiring brokers to be subject to a “best interest” standard, provide extensive disclosures regarding material facts and material conflicts of interest, and maintain policies and procedures designed to mitigate or even eliminate material conflicts of interest.
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As proposed, Form CRS would require broker-dealers, investment advisers, and dual registrants to provide a form in plain language to retail customers that would describe the firm’s relationships and services it provides to retail customers, including types of accounts offered. Form CRS would require each firm to describe the standard of conduct applicable to the firm (using wording prescribed by the SEC). Form CRS also would require firms to include a summary of fees and costs that a retail investor would incur. It would require stand-alone brokers to provide comparisons to stand-alone investment adviser services and vice versa. Form CRS also would prohibit a broker-dealer and its associated persons from using “adviser” or “advisor” as part of its name in communications with retail customers.
Finally, the stated purpose of the proposed Interpretive Guidance is to reaffirm and clarify the fiduciary duty that investment advisers owe to their clients under the Investment Advisers Act. Ropes & Gray submitted a comment letter on August 7, 2018, expressing our thoughts and concerns about the proposed interpretation.
Preliminary Insights from David Tittsworth, Counsel in Ropes & Gray’s Washington, DC office
“There are a lot of moving parts in these proposals. If these issues were subject to easy resolution, that would have happened years ago. I certainly do not expect there will be a short list of pat answers that will easily explain the final rules that we expect will be approved next week.”
Get Ready For Long And Complicated Releases
“Instead, these will be long and complicated releases that will require a good deal of work and analysis to digest and comprehend in order to determine appropriate courses of action. As the old sayings go, the proof will be in the pudding and the devil will be in the details. I think the main issues surrounding Reg BI will be to provide greater clarity around what the "best interest" standard means in actual practice and the number and specific disclosures that will be required. Chairman Clayton, officials at FINRA, and other Commissioners have made it clear that they want to preserve the broker-advice option – rather than requiring all brokers that provide advice to retail customers to register as investment advisers and be subject to the Investment Advisers Act fiduciary duty. But they have also made it clear that they will support a higher standard of care for brokers. The details of how that will be accomplished will be one of the most important aspects of the new rules.”
The Whipping Boy
“Form CRS has become the whipping boy for interest groups on both sides of the debate. The proposed form has been roundly criticized and I would be surprised if the final rule does not reflect significant changes. A couple of things to watch for is whether the final form will do away with the requirement that brokers provide information about investment advisory practices and vice versa. Brokers have strongly opposed the prohibition on using the terms “adviser” and “advisor,” though it is clear that these terms have contributed to investor confusion about the differences between brokers and investment advisers. Commissioner Peirce has been a strong advocate for allowing more flexibility in the form – both in terms of its substance as well as allowing for more presentation and delivery options that may utilize expanded technology alternatives.”
The Fiduciary Interpretation
“Based on comments we filed, our firm hopes that the final guidance will clarify certain aspects of the longstanding Investment Advisers Act fiduciary duty, and particularly the role of clear, thorough, and advance disclosure, as reflected in U.S. Supreme Court decisions and SEC pronouncements. The proposed interpretation also included a request for comment on several controversial expansions of investment adviser regulations. These include: federal licensing and continuing education requirements for investment advisers, providing account statements to clients, and imposing capital requirements on investment advisers. Investment advisory trade groups universally expressed very strong opposition to these proposed regulations.”
What about the Interest Groups?
“Interest groups have lined up on both sides of these issues for many years. On one side, advocates for the broker-dealer and insurance industries generally have opposed changing the current suitability standard and expanding disclosure and compliance responsibilities of these firms. On the other side, investment advisory and financial planning groups, consumer advocates, and state securities regulators generally have been aligned in urging the SEC to impose a fiduciary duty on brokers that provide investment advice to retail customers.”
What about Litigation?
“Litigation is certainly possible after the final rules are adopted, as exemplified in the FPA lawsuit where the DC Circuit Court of Appeals vacated an SEC rule in 2007 dealing with issues relating to broker-dealers establishing fee-based accounts, or more recently, as reflected in the 5th Circuit’s decision in 2018 that invalidated the Department of Labor’s fiduciary rule.”
“But before any lawsuits are filed, I expect there to be a lot of plain old legal digging – including those all-important footnotes – to try to figure out what the new rules require and what changes will be required by brokers, investment advisers, and dual registrants to comply with the new rules.”