Several Democratic members of Congress called upon SEC Chair Jay Clayton to amend proposed Regulation Best Interest ("Regulation BI") to require a uniform fiduciary standard for all broker-dealers and investment advisers.

According to a letter written by Representative Maxine Waters (D-CA), Congressman Bobby Scott (D-VA), Senator Sherrod Brown (D-OH) and Senator Patty Murray (D-WA), "Regulation BI falls woefully short" of its goal to ensure that certain financial professionals prioritize the best interests of their retail clients. The ranking member argued that the SEC's proposed application of two distinct standards for broker-dealers and investment advisers (the "best interest" standard and "fiduciary" standard, respectively) fails to meet the requirements set by Congress. The letter urged the SEC to conduct rulemaking under Dodd-Frank Section 913(g), which provides the SEC with the authority to create a uniform fiduciary standard for both broker-dealers and investment advisers.

In addition to creating a uniform fiduciary standard, the authors urged, the SEC should amend proposed Regulation BI to:

  • clarify the distinction between the proposed "best interest" standard and the current "suitability" standard;
  • clarify that written policies and procedures regarding conflicts of interest should reduce the impact of conflicts to ensure compliance with the best interest standard;
  • revise required disclosures based upon investor testing and public comment; and
  • "adopt a more principles-based approach to preclude broker-dealers from holding themselves out as investment advisers or acting in an advisory capacity."

Over thirty House and Senate Democrats cosigned the letter.

Commentary / Steven Lofchie

This letter is somewhat of a mixed bag of (i) selective quoting of Dodd-Frank, (ii) fair points as to the deficiencies of Regulation BI and (iii) regulatory and legislative proposals.

To start with the quoting of Dodd-Frank, paragraph (g) of Section 913 begins with the words: "The Commission may promulgate rules . . . " The plain reading of the paragraph is that the discretion as to whether to adopt the rules was left to the determination of the SEC. In fact, Section 913(b) directs the SEC to conduct a study and Section 913(d) directs the SEC to produce a report on the relevant issues; it is hard to see what purpose the study or the report would serve if the end result were mandated by Section 913(g), as the letter suggests.

As to the fair criticisms, there was agreement among the various SEC Commissioners (leaving aside perhaps the Chair) that key terms in Regulation BI are not sufficiently defined.

As to the most significant proposal - that broker-dealers be prohibited from acting in an advisory capacity - it seems implicit that such a move would kill the "full service" brokerage model. That model, in which an entity provides both transactional investment advice, subject to a suitability standard, and securities execution, for an execution fee is likely the most common model under which retail investors obtain brokerage services, so the change suggested is quite radical. The letter writers, in effect, argue that such services are inherently too conflicted. Though this position is not absurd; neither is it obviously true, as many investors have chosen the model, they obviously think it is best for them. It is also important to bear in mind that many investors who currently use "full service" brokerage would have to pay higher fees, perhaps materially higher, if they were required to pay for investment advice separate from full-service brokerage. That may be an acceptable result. What is not right, however, is that proponents of the position concede neither that this is the logical result nor that the position has a material downside in terms of costs to retail investors.

It is also worth noting, if not only for its "tone," that the letter strongly suggests that investors lost billions because of the conflicts of retail brokers. The financial crisis was not caused by the conflicts of full-service, retail brokers. Lots of entities and individuals whose money was managed by investment advisers also lost money.

It would make an interesting study to see what the relative performance has been of retail clients using full service brokers vs. those using investment advisers over some prolonged period of time. If we can put a man on the moon, then certainly such a study must be possible.

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