SEC approves new rule for financial advisers, setting stage for legal challenge

SEC approves new rule for financial advisers, setting stage for legal challenge
© Greg Nash

The Securities and Exchange Commission (SEC) on Wednesday approved new financial advisory standards for stock brokers and financial advisers, likely setting up a legal battle with consumer advocates who have called for stricter rules.

The Republican-controlled SEC voted along party lines to finalize a package of four measures aimed at enhancing and clarifying rules on broker-dealers and investment advisers while limiting conflicts of interest with their clients.

SEC Chairman Jay Clayton, along with GOP Commissioners Hester Peirce and Elad Roisman, voted for the measures. Robert Jackson Jr., the agency’s sole Democratic commissioner, voted against them.


“This action is long overdue,” Clayton said Wednesday, touting the SEC “staff’s decades of experience and expertise, the information and feedback we received from investors and other market participants” in the 14 months since the package was proposed in April.

The SEC rule comes almost a decade after the 2010 Dodd-Frank Act ordered the agency to write regulations for broker-dealer and investment advisers. Last year, a tougher rule issued in 2016 by the Obama Labor Department was struck down in federal court.

Dodd-Frank empowered the SEC to set a universal standard for broker-dealers and investment advisors. But the commission made little headway on the rule under former SEC Chair Mary Jo White, drawing ire from progressive politicians.

Amid pressure from consumer activists and their allies in Congress, the Labor Department preempted the SEC in 2016 and released its own proposal. That rule required broker-dealers to adopt the “fiduciary” standard applied to investment advisers, which imposed strict conduct requirements to protect retail investors.

A federal court struck down the Labor Department rule in June 2018, just two months after the SEC finally released its own proposal in April 2018.

Unlike the Labor Department, the SEC set different codes of conduct for broker-dealers and investment advisers. The agency’s proposal instead requires broker-dealers to act in what they believe is the customer’s “best interest” when making specific investment recommendations, but not does create a long-term duty to look out for the client.

“While both broker-dealers and investment advisers play important roles in helping retail investors achieve their long-term financial goals, they do so in significantly different ways,” Clayton said Wednesday.

“A ‘one size fits all’ approach to regulating standards of conduct for financial professionals presents significant risk,” he added.

Wall Street trade groups and investment firms complained that the Labor Department rule imposed needless regulatory burdens that would raise costs and keep investors from getting affordable financial advice.  

The centerpiece of the new SEC proposal, a rule dubbed Regulation Best Interest, sets new standards for broker-dealers, with the goal of ensuring they provide clients with the financial products best suited to their needs.

The rule imposes a code of conduct for broker-dealers that requires them to prioritize the financial needs of customers over fees or commissions they would receive from selling a less suitable product.

The rule also instructs broker-dealers to mitigate or eliminate potential conflicts of interest by disclosing any financial incentives the broker has to sell certain products. The broker-dealer must also “exercise reasonable diligence, care, skill, and prudence” to ensure their recommended products are in the customer’s best interest.

The industry on Wednesday hailed the proposal.

“The Commission will bring certainty to Main Street investors, working families saving and investing for a better future, and financial professionals across the country who do the right thing every day,’ said Chris Iacovella, president and CEO of the American Securities Association, a trade group for regional investment firms.

“This vote further solidifies Chairman Clayton’s investor-first legacy and re-establishes the SEC as the proper regulator of relationships between firms and their customers”

But Democrats and consumer advocacy groups blasted the proposal, calling it too weak to protect average investors when it comes to receiving financial advice.

Jackson, the sole Democratic commissioner, dismissed the proposal as “a policy choice in legalese” that would “fail to arm Americans with the tools they need to survive the nation's retirement crisis.”

“Rather than requiring Wall Street to put investors first, today's rules retain a muddled standard that exposes millions of Americans to the costs of conflicted advice,” Jackson said.

Jackson, who will depart the SEC this year, urged critics of the proposal to fight for stronger rules ahead of a likely court battle.

Consumer advocates said the SEC rule is too vague and lenient to prevent retail investors from facing conflicted investment advice. Critics of the rule have called on the SEC to impose a fiduciary standard on broker-dealers and ban pay-based incentives tied to product sales.

“The Commission just threw investors under the bus,” said Barbara Roper, director of investor protection at the Consumer Federation of America (CFA), in a Wednesday tweet.

In a 24-page April letter to Clayton, CFA and  other consumer advocates called on the SEC to ban financial incentives that could create conflicts of interest, force broker-dealers to consider a wider array of products and protect investors from the costs of conflicted recommendations.

The SEC on Wednesday also approved an updated form through which a broker-dealer or investment adviser explains their duties to a customer and explains the agency's standard of conduct for investment advisers and what advice is subject to the broader rule.

The SEC’s interpretation of an investment adviser’s fiduciary duty also raised alarm among critics of the proposal, including the commission's investor advocate, Rick Fleming.

Fleming said that the SEC adopted the position that an investment adviser’s fiduciary duty can be upheld merely by disclosing conflicts of interest. He argued that doing so effectively weakens the fiduciary standard, meant to be the strictest code of conduct applied on investment professionals by the SEC.

“I do not believe this is what an investor would reasonably expect from a fiduciary, nor does it align with the ways that real-world investment advisers tend to view and describe their fiduciary obligation,” Fleming said.

Updated at 3:01 p.m.