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Reg BI is “Worse Than Doing Nothing,” Says This Consumer Advocate

By Rita Raagas De Ramos June 7, 2019

Micah Hauptman, financial services counsel at the Consumer Federation of America, has been among the vocal critics of the SEC’s Regulation Best Interest since it was proposed in April last year.

At CFA, he conducts research and engages in advocacy on investor protection and systemic risk issues, focusing primarily on a fiduciary standard for investment professionals, adequate funding for financial market regulators, credit rating agency regulation, investor arbitration and financial market structure.

Hauptman explains to FA-IQ why he believes Reg BI is not an improvement over Finra’s suitability rule; gives broker-dealers cover to provide advisory services under its “solely incidental” interpretation; is misleading to investors who may assume their brokers are providing them with higher quality advice than they’re legally required to provide; and weakens the interpretation of the fiduciary duty of advisors.

FA-IQ: Have you read the SEC’s entire Regulation Best Interest package – the standard of conduct for broker-dealers, the new Form CRS Relationship Summary, and the two separate interpretations under the Investment Advisers Act of 1940? What jumped out at you based on your initial reading of the package? [Editor’s note: The entire package has a total of 1,363 pages.]

Micah Hauptman

Hauptman: I haven’t gotten through all of it yet. So far, I’ve read the two interpretations under the Advisers Act and the Reg BI release up to the economic analysis. I haven’t begun to read the CRS release.

My initial reaction is that Reg BI is largely the same as proposed. It’s still not at all clear whether or how it would be a real improvement over Finra’s suitability rule. In many cases, it’s clear that Reg BI is merely codifying Finra’s suitability rule and its related guidance and case law into the federal securities laws.

My initial reaction to the IAA fiduciary interpretation is that, in the name of interpreting and clarifying what the IAA fiduciary requires, it enshrines the weakest possible interpretation of the IAA fiduciary duty, undercuts prior guidance on what the IAA fiduciary requires, and sends a disturbing signal to firms that they can, in virtually all instances, rely on disclosure alone to address their conflicts of interest. This will increase the likelihood that investors will be harmed by advisors.

Regarding the ‘solely incidental to’ interpretation, this is an example of the SEC’s doubling down on its flawed policy, which is legally unsupportable, to give broker-dealers unlimited cover to provide what any reasonable person would understand as advisory services without having to register as advisors.

While I haven’t read the CRS release, my initial reaction based on the discussion at the open meeting is that, in allowing firms flexibility to describe their services, it will reduce comparability and render these disclosures little more than firm marketing materials. These were already useless disclosures to begin with, but now I worry that they will have the potential to be very misleading to investors.

FA-IQ: You’ve been among the vocal critics of Reg BI since it was proposed in April last year. Has the final rule package appeased any of your concerns, or has it worsened them?

Hauptman: In some cases, the SEC made certain changes and clarifications that we asked for, and I appreciate that. For example, they clarified that Reg BI applies to account recommendations, including rollover, transfer and account opening recommendations. They also included language in the operative provisions of the rule, which states that a broker-dealer may not place its own interest ahead of the interest of the retail customer. But these modest improvements don’t make up for the fact that the rule is still incredibly weak and doesn’t appear to raise the standard for brokers beyond Finra suitability in any meaningful way.

We asked more times than I can count for the SEC to give examples of practices that are currently permitted under Finra suitability but would be prohibited under Reg BI and they never provided an answer. They still haven’t in the final rule, which strongly suggests that they have no interest in meaningfully moving beyond Finra suitability. The one exception to this is with product-specific sales contests, quotas, bonuses and non-cash compensation within a limited time period, but even these are largely already addressed by Finra rules for mutual funds, variable annuities and direct participation programs, for example. So Reg BI would expand those limitations outside of those securities, but they’ve defined this so narrowly that it doesn’t begin to address the full range of incentives firms intentionally create that encourage and reward harmful advice.

FA-IQ: What’s your biggest criticism about the final rule package?

Hauptman: I have many criticisms. But I’ll provide one overarching criticism, which is, the SEC could have meaningfully improved protections for investors by following the will of Congress as set forth in section 913(g) of the Dodd-Frank Act and promulgating a uniform fiduciary duty for brokers and advisers alike. Under that standard, any personalized advice would have to be made ‘without regard to’ the financial or other interests of the financial professional or firm.

The SEC staff recommended that the SEC engage in rulemaking under 913(g), but Chairman [Jay] Clayton refused to follow that recommendation. Instead, the SEC is failing to improve protections for investors who turn to broker-dealers for advice and dumbing down protections for investors who turn to investment advisers for advice.

This approach to steer clear of section 913(g) was a conscious choice. In large part, it is the result of the DOL’s having used the 913(g) language in its fiduciary rule and industry’s making clear early on that it vehemently opposed the use of that language. Rather than distinguish between 913(g) and the DOL rule, which included many other aspects in addition to the 913(g) language, follow the clear will of Congress, and adopt a pro-investor rule under 913(g), Clayton clearly let the politics surrounding the DOL rule taint his view and decided early on to disregard 913(g). That’s a political decision, not based on serious analysis, and beneath the dignity of the agency.

FA-IQ: What do you say to advocates of Reg BI who say that any improvement to investor protection is better than nothing?

Hauptman: This is actually worse than doing nothing. Now, broker-dealers are going to be allowed to claim that they are legally required to serve investors’ best interests, but nothing in the rule would meaningfully improve existing protections or practices. As a result, investors will be misled into trusting that their brokers are providing higher quality advice than they’re legally required to provide, and investors will continue to lose tens of billions of dollars every year because of it. Some investors, who otherwise wouldn’t use a broker, might choose to use one, based on the statement that the broker is legally required to serve the investors’ best interest. Those investors could be harmed in ways they otherwise wouldn’t be.

On the advisor side, there are advisors who otherwise would seek to avoid conflicts because they were under the legitimate impression that was what was required of them, but who now will decide that disclosing conflicts in their Form ADVs is easier and more profitable for them. As a result, investors who use these advisors will be exposed to more conflicts of interest and worse advice.

FA-IQ: Are you counting on various state regulators to step up to fill the void that you believe the SEC has left with Reg BI?

Hauptman: Yes, given the fact that the SEC has failed miserably to protect investors from conflicted advice, it is entirely appropriate that state regulators step in to fill the void. They can and should provide the protections that investors reasonably expect and need.

FA-IQ: At the SEC open meeting to vote on Reg BI, Chairman Jay Clayton said a patchwork approach to the regulation of retail investment advice will increase costs, limit choice for retail investors and make oversight and enforcement more difficult. What is your reaction to that?

Hauptman: It’s troubling that Chairman Clayton is relying on the same talking points that the broker-dealer industry routinely uses. After all, from an investor point of view, state laws that apply a strong, consistent standard across accounts are far less confusing. But what’s even more concerning is that the release almost seems to be coaxing the industry to challenge state fiduciary rules on preemption grounds, which I find highly improper.

FA-IQ: At the same SEC meeting, Chairman Jay Clayton said because the markets are “ever changing … we and our successors will need to assess our efforts and make adjustments.” Does that make you optimistic that the significant investor protection measures you would want could still find their way into SEC rules?

Hauptman: First, I think this rule has a short shelf life and the next Democratic administration will revisit the issue entirely. That would be the cleanest way to fix all of the problems with the rule package. But short of starting from scratch, I do think there could be opportunities to fix some of the problems with the rule and provide some meaningful improvements, particularly around the conflict mitigation obligation. I also think there could be opportunities to give Reg BI some real meaning through enforcement. But frankly, given the agency’s anemic approach to enforcement, I’m not holding my breath.