SEC votes to open fiduciary regs for public comment, despite commissioners’ misgivings

The Securities and Exchange Commission voted today to release a three-pronged proposed rule for public comment that would change the standard of care broker-dealers owe retail investors, require new client disclosures for all investment providers, and reinterpret the requirements of fiduciary advice.

The total proposal ranges 1,000 pages in length. The public will have 90 days to comment after the proposal is published in the Federal Register this week.

On each of the three measures, the five-member commission voted 4-to-1 to release the proposals to the public, with Commissioner Kara Stein, a Democrat and appointee of President Obama, the lone “no” vote on each proposal.

While the vote is a vital step in advancing new standards and disclosures that would impact all broker-dealers and investment advisers, it still marks the early stages of what is setting up to be a contentious debate over what a final rule should look like.

Ms. Stein, a former Senate staffer who had considerable input crafting the Dodd-Frank Wall Street Reform Act, lambasted the proposal in her comments.

“Today’s proposal fails to provide comprehensive reform, or adequately enhance existing rules,” said Ms. Stein, who claimed the SEC “squandered” an opportunity to act in the best interest of investors.

Perhaps the most impacting of the three proposals—the Regulation Best Interest—intends to require a best interest standard of care for broker-dealers that currently operate under a suitability standard.

Under the proposal, brokers would be required to disclose conflicts of interest and have a “reasonable basis” that their recommendations were in clients’ best interest.

Ms. Stein was dismissive of the notion that the proposal reflects a best interest standard, calling it a “safe harbor” for broker-dealers.

“It is hard to fathom why we are being asked to vote on this proposal today,” said Ms. Stein, adding that the proposed Regulation Best Interest merely reaffirms brokers’ existing suitability standard.

“Most of this is already required by FINRA or federal securities laws,” Ms. Stein added. “It protects the broker-dealer, not the customer. “Unfortunately, we are not proposing a best interest standard.”

Chair Clayton pushes back

Later in the hearing, SEC Chairman Jay Clayton addressed commission staff, seemingly as an indirect response to Ms. Stein’s claims, by asking if the proposal raises broker-dealers’ standard of care.

“The proposal makes it clear broker-dealers could not put their best interest first,” Chair Clayton said.

Others on the Commission reported their misgivings for the new broker-dealer standard of care, albeit for different reasons.

“The devil truly is in the details,” said Commissioner Michael Piwowar, a Republican Obama-appointee who reiterated his unapologetic disdain for the Labor Department’s fiduciary rule during the hearing.

The proposal’s new best interest standard for broker-dealers is distinct from investment advisers’ fiduciary standard and FINRA’s suitability standard, said Piwowar.

“But I’m still not convinced we’ve explained the differences,” added Mr. Piwowar. He also raised the question of whether the proposal would increase brokers’ compliance costs so much that it would discourage them from offering the option of transactional advice.

Piwowar’s support for the SEC’s overall proposal came with “misgivings for some of the package,” he said. “The size alone gives me pause.”

New Commissioners weigh in

Commissioner Robert Jackson, a newly minted Democrat appointed by President Trump, said “enormous” gaps in securities laws have hurt investors.

He reluctantly supported advancing the proposal, but suggested it needs significant changes.

“I could not support this proposal as a final rule,” said Mr. Jackson, a strong supporter of Labor’s fiduciary rule.

But the need for SEC action has been made all the more urgent by the Fifth Circuit Court of Appeals’ decision vacating Labor’s fiduciary rule, said Mr. Jackson, who called that court ruling “profoundly misguided.”

Commissioner Hester Pierce, a Republican Trump-appointee who worked at the SEC earlier in her career, matched Ms. Stein’s color in conveying reservations for the proposed broker-dealer best interest standard, but for much different reasons.

“How will the term be used?” asked Ms. Pierce. “’Best Interest’ sets an impossible standard. After many years, I haven’t found anyone that can explain what it means.”

Ms. Pierce likened the terms “best interest” and “fiduciary” to a “spell that charms investors into not asking questions.”

Brokers’ existing suitability standard has served investors well, added Ms. Pierce, while the SEC’s proposals lack clarity. “If it’s not refined, it will be unworkable,” she said of the overall proposal.

New disclosure for all; a new interpretation of advisers’ fiduciary standard

The SEC also advanced a new disclosure requirement for advisers and brokers that would prevent the latter from calling themselves “advisers” or “advisors,” and a new proposal that would clarify registered investment advisers fiduciary obligations.

A Customer Relationship Summary, or Form CRS, would be limited to four pages in length, and would include descriptions of services offered, legal standards of conduct, fees, and conflicts of interest. It would also offer questions and talking points for customers to ask.

Criticisms for the proposal came from across the Commission. The CRS would also mandate disclosure of services a provider did not offer, something Ms. Pierce called “unusual.”

While she backs disclosure as the centerpiece for reform, Ms. Pierce said the proposed CRS needs considerable input from the public. “I’m concerned the approach we are taking is a few more pages of unread paper.”

The proposal to interpret the term fiduciary for registered advisers would clarify aspects of the duties advisors owe their clients.

But members of the Commission pushed back on that proposal too, suggesting the SEC may not have the statutory authority to override common law, and Congress, in potentially redefining the term fiduciary.