Securities Regulation Daily Stein blasts SEC’s proposed broker standards, Piwowar approves with misgivings
Thursday, April 19, 2018

Stein blasts SEC’s proposed broker standards, Piwowar approves with misgivings

By John M. Jascob, J.D., LL.M.

SEC Commissioner Kara Stein sharply criticized the Commission’s proposed rulemaking package concerning the standards of care for investment advice given by broker-dealers and investment advisers. As the sole commissioner voting against releasing the proposals for public comment, Stein said that the agency had squandered an opportunity to act in the best interest of investors by failing to propose a fiduciary duty standard for brokers giving advice. Commissioner Michael Piwowar, who voted in favor of the proposals, also expressed some misgivings, questioning in particular whether the necessary legal authority exists to support the agency’s proposed interpretation of an investment adviser’s fiduciary duty.

"Regulation Status Quo." Turning first to proposed Regulation Best Interest, which would impose a "best interest" standard of conduct on brokers when recommending securities transactions to retail customers, Stein said that the proposal might be more accurately called "Regulation Status Quo." She observed that the proposal merely reaffirms a broker dealer’s existing suitability obligations while requiring policies and procedures and a few disclosures, most of which are already required by FINRA or the federal securities laws. In the commissioner's view, the minimal obligations imposed on a broker-dealer create a safe harbor that serves to protect the broker-dealer, not the customer.

Stein noted that the very name of the proposed regulation is confusing and potentially misleading to investors because the rule text does not even define what "best interest" means. Moreover, the lack of a definition of best interest, the use of similar terms to mean different things, and the possibility that the SEC and FINRA interpret the language in their suitability standards differently may result in higher compliance costs for broker-dealers. These costs likely will be passed onto investors, Stein noted, and the lack of a clear standard is not likely to give investors more confidence in the broker-dealer business model.

Inadequacy of proposed disclosures. Among her other comments,Stein also took issue with the proposal requiring an investment adviser or a broker-dealer to provide a brief relationship summary to retail investors to inform them about the relationships and services it offers. She wondered whether the proposed disclosure is both too generic and too legalistic, with the result being that retail investors won’t bother to read it. In her view, the disclosure should provide a retail investor with a meaningful understanding of the application of the financial professional's obligations to the investor. Without this type of disclosure, retail investors may simply set aside or discard the relationship summary along with the rest of the boilerplate disclosures they receive.

Piwowar’s comments. Commissioner Piwowar began by observing that all eyes are now on the SEC after the Fifth Circuit vacated the Department of Labor’s controversial fiduciary duty rule in March. Piwowar, who had previously lambasted the DOL for adopting a "terrible, horrible, no good, very bad" rule, said he was happy to support all three of the SEC’s recommendations in seeking to provide a workable, non-political path forward. Nevertheless, Piwowar expressed some doubts, including about the very size of the rulemaking package, which comprised about 1,000 pages. Given the massive page count, Piwowar wondered whether the Commission’s proposed solutions might lack the clarity necessary to address retail investors’ confusion.

Piwowar said that he hopes to hear from a wide range of commenters—including consumer behavior researchers in economics, marketing, and advertising—who can help the Commission make the proposed relationship summary on Form CRS more effective at conveying information in a way that retail investors can understand. Although the relationship summaries are meant be clear and concise, Piwowar said that a readability calculator shows that the summaries are about as comprehensible as Herman Melville’s Moby Dick.

Piwowar welcomed, however, the Commission’s attempt to prevent potential harm to retail investors from the use of misleading titles by financial professionals. He observed that under current regulations, anyone can call herself a financial "adviser," regardless of whether they are registered in that capacity. Referencing a humorous "Bachelor of Financial Advising" certificate that he had received from the website of comedian John Oliver, Piwowar said he found it hard to argue with Oliver's view that the term "financial adviser" doesn’t necessarily mean much. While joking that the Commission’s proposal would ultimately limit his own "financial advising" activities, Piwowar said he was willing to make that "sacrifice" in order to ensure greater clarity for retail investors.

Standard of conduct for investment advisers. Regarding the proposed interpretation of the standard of conduct for investment advisers, Piwowar noted that the Advisers Act prescribes few particular obligations related to an adviser’s fiduciary duty. As a result, the SEC’s proposed interpretation draws upon inferences from common law principles and generally cites to treatises and law review articles for support. In his view, the relative lack of case law underpinning the interpretation raises questions about the Commission’s legal authority to issue this guidance. He hopes that commenters will fill in any gaps in the Commission's analysis to bolster the common law support for the propositions in proposed interpretation. If that support is not available, however, the Commission should consider engaging in rulemaking rather than attempting to impose requirements through guidance if the agency still believes that certain obligations merit the Commission’s imprimatur.

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