On April 18, 2018, the U.S. Securities and Exchange Commission (“SEC”) announced proposed rules that would require broker-dealers to act in the best interests of their retail clients when recommending investments. The SEC opened the proposed rules to a 90 day comment period.
This announcement follows a March 15, 2018 decision by the U.S. Fifth Circuit Court of Appeals that vacated the so-called “Fiduciary Rule” promulgated by the U.S. Department of Labor (“DOL”) covering retirement fund investment advice. The Fiduciary Rule, in actuality a package of seven rules that broadly reinterpret the term “investment advice fiduciary” and related exemptions codified in the Employee Retirement Income Securities Act of 1974, 29 U.S.C. § 1001, et seq. (“ERISA”), and the Internal Revenue Code, 26 U.S.C. § 4975, would have expanded the definition of fiduciary thereunder to the extent a person is compensated in connection with a “recommendation as to the advisability of” buying, selling, or managing “investment property.” 29 C.F.R. § 2510.3-21(a)(21) (2017). The Rule imposed on all those within the expanded definition of fiduciary an obligation to act in the best interest of their clients and avoid conflicts of interest.
Following the adoption of the Fiduciary Rule by the DOL, the SEC began its own consideration of broadening the scope of fiduciary obligations under SEC rules. While the SEC’s newly proposed rules are more lenient than the Fiduciary Rule, their advancement nevertheless will have a major impact on the investment community.
The Fifth Circuit Decision
On March 15, 2018, the Fifth Circuit Court of Appeals vacated the DOL’s Fiduciary Rule in its entirety. Chamber of Commerce of the United States of America, et al. v. United States Department of Labor, No 17–10238 (5th Cir. March 15, 2018). That decision was grounded on two major findings. First, the court ruled that the DOL did not have the authority to adopt a definition of “fiduciary” that is inconsistent with the statutory definition in ERISA. Second, the court found that the DOL violated the Administrative Procedures Act by acting in an arbitrary and capricious manner in adopting an unreasonable definition.
An earlier decision by the Tenth Circuit Court of Appeals affirmed a lower court decision upholding the Fiduciary Rule as related to fixed indexed annuity sales. The DOL may pursue further appeals from the Fifth Circuit decision, either by petitioning the Fifth Circuit for rehearing en banc or by petitioning the U.S. Supreme Court for permission to appeal.
The SEC Proposed Rule
On April 18, 2018, the SEC voted in favor of proposing a package of two new rules and interpretations affecting both broker-dealers and investment advisers. The package, known as “Regulation Best Interest,” has several components. First, broker-dealers would be required to act in the best interest of their retail customers when making recommendations of any securities transaction or investment strategy involving securities. Second, Regulation Best Interest includes an interpretation that reaffirms and clarifies the SEC’s views of the fiduciary duty that investment advisers already owe to their clients. Third, it would require that investment professionals provide their retail customers a short form disclosure document, known as a customer or client relationship summary, setting forth a simple and easy to understand summary of the nature of their relationship with their investment professionals. Lastly, Regulation Best Interest would restrict certain broker-dealers and financial professionals from using the terms “advisor” or “adviser” as part of their name or title with retail investors, unless they are actually registered as one.
The proposal was adopted by a four to one vote of SEC Commissioners. One SEC Commissioner, Kara Stein, dissented saying that the proposed standards fall short of the real reform that is necessary to curtail conflicts that impact individual investors. She additionally complained that nowhere in the proposed changes was a definition established of what constitutes an investor’s best interest. And while Commissioner Robert Jackson voted in favor of opening the package of proposals for public comment, he said he would not ultimately vote to adopt them if they remained in their current form.
The SEC’s Regulation Best Interest proposal has a long way to go to get across the finish line of adoption. The 90 day comment period undoubtedly will be robust. Uncertainty exists over whether the proposal will ever be adopted. But if it is, it seems likely it will be in a substantially different form than that currently proposed.