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Op Ed: The SEC Needs to Keep a Decades-Old Promise to the Investing Public

The brokerage industry loves Regulation Best Interest. Investors shouldn't.

“Promises and pie-crust are made to be broken.”
                                                   --Jonathan Swift

The SEC’s effort to impose a “best interest” standard on brokers is heading in a bad direction for the investing public.  The SEC’s proposed Regulation Best Interest would leave the door open to a range of practices that will allow brokers to continue to provide conflicted advice.

A 2015 White House study estimated that conflicted advice could shave 1% off the investing public’s retirement savings annually, costing them $17 billion every year.  That’s a lot of money.

But worse, there should not even be a debate about whether brokers can continue to provide conflicted advice.  Decades ago Congress and the Supreme Court established the standard applicable to all those who provide advice.  The SEC just needs to enforce it.

When Congress passed the Investment Advisers Act of 1940 (the “Act”), it made a distinction between brokers and advisors.  Those who give advice about the purchase or sale of securities are considered “investment advisers” and must register under the Act (“RIAs”). 

But there’s an exception.  Brokers aren’t considered to be investment advisers and aren’t required to register as RIAs if they meet two conditions.  First, any advice they give must be “solely incidental” to their work as a broker—that is, executing transactions.  Second, they must not receive any “special compensation” for that advice.

The Act does not specifically articulate a fiduciary duty applicable to RIAs.  However, in 1963 the Supreme Court ruled in SEC vs. Capital Gains Research Bureau that advisers subject to the Act have a fiduciary duty to their clients.  Pretty simple--no wiggle room.

In 1940 when the Act was passed and in 1963 when the Supreme Court handed down its decision, it was easy to tell a broker from an RIA.  RIAs charged fees for their services and provided ongoing advice.  Brokers executed transactions and were paid commissions for their services. They might offer some “solely incidental” advice along with their recommendations, but such activity was contemplated by the Act and did not trigger registration as an RIA.  (“Mrs. Smith, our firm thinks this stock is going to the moon.”)  A lot has changed since then.

Brokers have positioned themselves more and more to compete directly with RIAs.  They use titles like “financial advisor,” or “wealth manager,” even if they are compensated on a commission basis.  They provide ongoing advice to clients and those clients view their brokers as their advisors, just as their titles suggest.  Why aren’t these brokers subject to the Act and its fiduciary duties just like RIAs?  The SEC has not provided a good answer to this question.

Instead, the SEC seems to be taking what might charitably be described as a practical approach to imposing an enhanced standard of behavior on brokers.  The Commission watched the years-long spectacle of the brokerage and insurance industry buzz saws chewing up the Department of Labor’s fiduciary rule.  Understandably, the SEC wants to shelter its rulemaking efforts from a similar fate.  It seems to be in search of a middle ground acceptable to the brokerage industry.

Apparently, they found it.  The brokerage industry loves Regulation Best Interest.  It fuzzes up the competitive advantage RIAs have had for years by leaving brokers looking like they are subject to the same standard as RIAs.  (Doesn’t a fiduciary standard require an advisor to act in a client’s “best interest”?) 

Yet, it allows brokers to continue the practices that are costing retirement savers billions each year.  Earning commissions on the sale of products to clients, principal trading, and selling proprietary products are all allowed under Regulation Best Interest. What’s not to like?

This seems like a misguided approach to dealing with the problem.  The unfortunate result will be that RIAs and brokers who provide essentially indistinguishable services will be subject to different standards of behavior—standards which, themselves, will be indistinguishable to the public.  This violates the policy that is in favor of regulating similar behavior in a similar manner.

But more importantly, it leaves investors without the protection they were promised by Congress and the Supreme Court decades ago.  Why?  To avoid getting into a dog fight with the brokerage industry?  Who else are investors supposed to look to for protection, if not the SEC?  Congress or the Supreme Court?  They already acted.

Investors need every bit of help they can get in saving for retirement.  A 2015 GAO report to Congress stated:

  • “About half of households age 55 and older have no retirement savings…”
  • “Among those with some retirement savings, the median amount of those savings is about $104,000 for households 55-64 and $148,000 for households age 65-74…” 

A Federal Reserve report published in 2018 stated that four in 10 households do not have enough in savings to cover a $400 emergency.  These are grim statistics.

The statistics on financial literacy in this country are even worse.  The SEC’s own 2012 study on financial literacy found that “US retail investors lack basic financial literacy,” “have a weak grasp of elementary financial concepts,” and “lack critical knowledge.”  Investors need help.

The brokerage industry has proven to be resilient over the years.  It has survived and even thrived under any number of monumental changes—Glass-Steagall, the end of fixed commissions, and Dodd-Frank to name a few.  Imposing a fiduciary standard on brokers who hold themselves out as financial advisors and provide advice that is more than solely incidental to their execution of transactions seems like small potatoes in comparison.  They have known about this standard for decades even though they have worked hard to avoid its impact.  History suggests they will do just fine even if they must play on a level playing field with RIAs.

This debate should focus on whether the SEC will extend to investors the protections they were promised decades ago.  Regulation Best Interest is a diversion and a smoke screen. Investors are not asking for a handout here, just protection for their hard-earned savings.  They are already entitled to this under existing law.  The SEC should make sure they get it.

 

Scott MacKillop is CEO of First Ascent Asset Management, a Denver-based TAMP that provides investment management services to financial advisors and their clients. He is an ambassador for the Institute for the Fiduciary Standard and a 40+ year veteran of the financial services industry. He spent the first 15 years of his career practicing securities and ERISA law in Washington, D.C. and started his career as an intern at the SEC. He can be reached at [email protected]

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