An SEC proposal to increase customer protections

An SEC proposal to increase customer protections
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Investors may soon see a much needed increase to consumer protection standards. In April, the Securities and Exchange Commission advanced a package of advice-standard measures including their own “Regulation Best Interest” (Reg BI), an enhanced version of the fiduciary rule for brokers.

In June, the U.S. Fifth Circuit Court of Appeals put the final nail in the coffin of the Department of Labor’s fiduciary rule for retirement accounts by ruling it an overreach of authority. The court held that the DOL’s “arbitrary and capricious” expansion of the term “fiduciary” rendered it inconsistent with stipulations in the Employee Retirement Income Security Act of 1974 (ERISA). Furthermore, the majority opinion clearly articulated that “the SEC has the expertise and authority to regulate brokers and dealers uniformly. DOL has no such statutory warrant.”


The DOL’s rule led to high costs, less choice, and fewer professional services and options for retirement savers. For example, Merrill Lynch preemptively reformed its business model to contend with the overbearing fiduciary rule by banning commissions on retirement accounts which forced clients to either endure higher fee-based costs, switch to a cheaper service, or leave the firm entirely. The SEC now has the opportunity to improve standards for all retail accounts by raising the threshold for brokers and modernizing the best interest principle to increase quality and transparency.


Current standards implemented by the Financial Industry Regulatory Authority (FINRA), a Congressionally authorized and SEC monitored self-regulatory organization regulating broker-dealers, are concerned with suitability. Brokers are required to recommend suitable securities or strategies based on client needs, leaving an opening for them to push alternatives generating a higher payout.

The SEC’s rule, on the other hand, is focused on higher customer protection and preserving retail investor choice. FINRA Rule 2111 requires brokers to employ a “reasonable” belief that their recommendations are suitable. For example, short-term investment instruments could be suitable for a 70-year-old retiree with a low risk tolerance, whereas a wealthy young entrepreneur with a long-time horizon could favor high yielding speculative investments. Reg BI elevates the standard to require broker-dealers make recommendations that are legitimately in their client’s best interest.

SEC Chairman Jay Clayton has defended the principles-based approach to accommodate the episodic nature of retail client-broker relationships. This structure is currently applied to the fiduciary standard under the Advisers Act that was created to monitor and regulate investment adviser’s activities, where it has succeeded in both implementation and functionality for decades without defining the term “fiduciary.” A facts and circumstances method, rather than a definition-based approach, allows for greater flexibility to discern a particular client’s best interest at a specific point in time.

It is important to remember that the rule has only been proposed and allows for comments and concerns to be raised, helping guide the rule to benefit as many consumers without overdue burden on the marketplace in terms of customers and compliance costs. For example, the definition “retail customer” in Reg BI must be harmonized with existing FINRA definitions that firms have built compliance and supervisory structures upon. Definitional inconsistencies will be costly to the industry, limiting customer choice and leading to confusion from overlapping procedures and cumbersome account adjustments. 

Additionally, “material conflicts of interest” must be redefined to extract meaningful disclosures in line with the Basic v. Levinson materiality standard that “an omitted fact is material if there is a substantial likelihood that its disclosure would have been considered significant by a reasonable investor.” As Reg BI is proposed now, materiality is far too broad and can overwhelm investors who hire advisors to simplify investment transactions.

The SEC package of advice-standard measures is proof that it is possible to better protect clients and raise the quality of recommendations by brokers to higher standards. Investors will be able to enjoy access to a wide range of brokers and services at an affordable cost. While the proposal marks a move in the right direction there is still work to be done to ensure customers receive the maximum benefit.

Christina Mitsopoulos is a securities policy associate at Americans for Tax Reform, a nonprofit group dedicated to promoting limited government.