An SEC plan to introduce a best-interest obligation for broker/dealers will soon face scrutiny from Congress' lower chamber.
Known as Regulation Best Interest, the SEC's three-part rule package was designed to enhance the relationship between investors and their financial advisers. The nearly year-old proposal would specifically require broker/dealers to act in their clients' best interests when providing investment advice, a standard that many on Wall Street pushed the agency to pursue as concerns mounted over the U.S. Labor Department's now-defunct Conflict of Interest Rule.
Now, four months after senators grilled SEC Chairman Jay Clayton about the proposal, a subcommittee of the House Financial Services Committee will hold a March 14 hearing on Regulation Best Interest. Democrats in the hearing are expected to zero in on the myriad concerns raised about Regulation Best Interest by the likes of former SEC economists, state securities regulators and consumer advocacy groups, some of whom claim the proposed reforms do not go far enough.
"I'm willing to take the chairman on faith that his intent with this rule is to strengthen protections for investors," said Barbara Roper, director of investor protection for the Consumer Federation of America, in an interview. "But if that's the case, there are a lot of changes that are going to need to be made between now and finalization."
At issue are concerns that some brokers exploit their mom-and-pop customers by guiding them into higher-priced investment products and strategies that may offer sales incentives for the broker. Regulation Best Interest would require brokers to disclose and mitigate any financial conflicts of interest when advising their clients. The rule would also mandate that brokers use “reasonable" diligence, care, skill and prudence to make sure the products or transactions they recommend are in the clients' best interests.
But critics of the proposal like Roper say the SEC's reforms provide a weakly defined best-interest standard that does not clearly raise the current suitability requirement brokers must meet.
The economic analysis behind Regulation Best Interest was also targeted by 11 of the SEC's own former economists in a Feb. 6 letter. The group expressed concerns that the analysis did not appropriately define the problem at hand; tie in prior economic literature on the topic; or determine whether retail investors would benefit from the regulation's requirement that brokers begin detailing information like potential conflicts of interest, fees and their disciplinary history in a single report known as Form CRS.
"If the commission is going to be a fact-based policymaker, they have to pay attention to facts," said Mark Flannery, who served as the SEC's chief economist from 2014 to 2016 and is now a finance professor at the University of Florida, in an interview. "This is not a good example of an economic analysis that is fact based."
Still, much of Wall Street says the SEC's proposed reforms signal a step in the right direction.
The Securities Industry and Financial Markets Association, a trade group representing the likes of J.P. Morgan Securities LLC, Prudential Financial Inc.and BlackRock Inc., applauded the SEC's proposal. While the wording around the rule's best-interest standard has faced scrutiny, SIFMA General Counsel Ira Hammerman said the requirements that brokers operate with diligence, care and skill when advising their clients are fiduciary principles.
Lawmakers including Sen. Elizabeth Warren, D-Mass., have said the SEC should have created a uniform standard that both registered investment advisers and brokers would have to meet. But Hammerman said the SEC was unable to do so because that could unnecessarily expose the reforms to potential legal challenges.
"It's a bit of apples to oranges," Hammerman said in an interview. "What the chairman is trying to do is pull the best ideas of what it means to be a fiduciary — using diligence, care and skill — but not importing all of the case law that's developed over these many years."
SIFMA also raised recommendations it believes the SEC should pursue as it finalizes the rule. Among other tweaks, the group specifically hopes the SEC will simplify its Form CRS so retail investors can better understand the information it shows.
The SEC is planning on finalizing the proposal by September, giving it six more months to sift through the thousands of comment letters that have amassed since the proposal was introduced roughly a year ago.
"We're working through the comments, and we're going to move forward as quickly as we can," Clayton said in a brief March 11 interview.