SEC's 'best interest' proposal falls short of its laudable goal

SEC's 'best interest' proposal falls short of its laudable goal
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On April 18, the Securities and Exchange Commission (SEC) took long-awaited action to propose new rules for broker-dealers and others, in particular, the standard of conduct for broker-dealers making securities recommendations to retail investors.

This was the second blow to The Department of Labor (DOL) effort to address broker transparency and conduct toward their retirement-account customers. In mid-March the DOL rule was all but quashed by the courts.


With the DOL effectively sidelined, it was expected that the SEC, in short order, would properly address brokers’ conflicted interests and mis-selling of high-cost products. Sure enough, about a month after the U.S. Court of Appeals for the Fifth Circuit vacated the DOL fiduciary rule in its entirety, the SEC acted.


It is high time regulators stepped up to address mis-selling by brokers. The issue has dragged on for decades without resolution, and investor confusion about the responsibilities of their brokers remains an ongoing problem.

The 90-day response period for the SEC’s proposals is relatively brief considering the nearly 1,000 pages of technical and legalistic rules commenters will have to cover.

These three months are critical, nevertheless, as they offer investors a vital opportunity to recommend improvements to the proposal which, while virtuous in its stated goal of enhancing broker-dealer standards, falls well short of this worthy endeavor.

Proposed form for disclosure by brokers as sales agents

On the virtuous side, the proposals would require broker-dealers and investment advisers to provide their customers with a new, customer relationship summary (CRS). The CRS would highlight the applicable standards of care, conflicts of interest, fees and the primary differences in the services each provided.

For brokers, this would mean full disclosure of their sales relationships. We believe such disclosures need to be brief, ongoing and fully understandable descriptions of the sales relationship; not some longer, one-time, legalistic missive delivered only when an account is opened.

Titles — adviser vs. advisor

The SEC is also proposing to restrict certain broker-dealers from using “adviser” or “advisor” as part of their titles when dealing with retail investors. We strongly support this prohibition for all brokers, particularly in retail situations.

Broker-dealers’ use of such titles has misled investors into thinking they were receiving a higher, fiduciary standard of care. It has been a root enabler of mis-selling of overpriced, conflicted financial products to retail investors, and this proposal, applied to all brokers, would be an excellent first step toward ending such practices.

Proposed Regulation Best Interest

Recently, a brokerage firm spokesman was quoted effectively saying that his firm operates with a fiduciary “mindset,” even though they owe no formal legal duty to the customer. It’s a brilliant marketing device, but total baloney when describing brokers’ true mindset.

What the SEC has proposed with regard to what it calls Regulation Best Interest raises similar concerns, unfortunately. We do not support its introduction of a new, “best interests” standard of care for broker recommendations.

Investors have survived for years with two simple standards and have shown they understand the distinctions between fiduciary advice, where customer interests are paramount, and investment sales, where brokers do not have to put customer interests first.

Rather than enhance clarity between these two standards, however, this proposed regulation would introduce greater investor confusion. Its requirement that a broker-dealer act in the "best interests" of a retail customer when recommending any securities transaction or investment strategy involving securities to that customer, laid out over hundreds of pages, is a perfect example.

First, it expressly refuses to define what it means by best interests. It would then allow, among other things, “a broker-dealer to recommend products that may entail higher costs or risks for the retail customer, or that may result in greater compensation to the broker-dealer than other products, or that may be more expensive, provided that the broker-dealer complies with the specific Disclosure, Care, and Conflict of Interest Obligations.”

This doesn’t fit with our view of what best interests means, and it is unlikely it will concur with what investors think acting in their best interests means, either.

Instead of yet another — a third — standard of care for brokers who want to provide personalized advice to retail investors, we support a uniform fiduciary standard for all who provide personalized advice to retail investors. To be blunt, this "best interest" standard is a confusing mess that does little or nothing to fix the mis-selling abuse.

Retail investors deserve more clarity around the critical allegiances of the people giving them investment advice. These proposals take steps toward providing that, but in bigger ways will likely contribute unnecessarily to greater, rather than less, investor confusion over the long-term.

Our investment industry regulators need to stand tall and address the interests of long-suffering savers by fulfilling their broader expectations for investor protection. These proposals are a first step in that direction. But many additional steps in the right direction remain.

Kurt Schacht is the managing director at the CFA Institute, a global association of investment professionals.