SEC’s Best-Interest Broker Rule Proposal Criticized By State Regulators
August 10, 2018 by Tracey Longo
State securities regulators say they are squarely behind raising broker-dealer standards of care, but don’t see that being accomplished through the SEC’s Reg Best Interest proposal.
In fact, the SEC proposal “would leave broker-dealers in a position to put their own interests ahead of their clients,” Joe Borg, president of the North American Securities Administrators Association, said in a preliminary comment letter to the SEC on the proposal.
The SEC proposal gives broker-dealers too much interpretative leeway when it comes to deciding what best-interest practices mean, said Borg, director of the Alabama Securities Commission. “For instance, Regulation Best Interest should explicitly prohibit certain conflicts tied to agents’ financial incentives, not merely leave it to broker-dealers to evaluate whether they have cured such conflicts through adequate disclosures and mitigative measures,” he said.
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In a letter addressed to SEC Chairman Jay Clayton and his fellow securities commissioners, Massachusetts Secretary of the Commonwealth William F. Galvin echoed those comments, saying that the SEC was proposing a weak and unclear standard that, unless modified, would force Massachusetts to adopt its own rules to protect investors and require broker-dealers to provide non-conflicted advice in the best interest of their clients.
Galvin further stated that it is his belief that the SEC’s proposal presents “merely a veneer of a fiduciary standard” and that the substance of the proposal will allow existing weaknesses in Finra’s suitability standard for brokers to persist.
The SEC proposed Reg BI earlier in the year to ostensibly clear up investor confusion between the differences between registered investment advisors and brokers. Under current law, advisors are held to a fiduciary standard that requires that they put client best interests before their own. In contrast, brokers are held to a suitability standard that does not require them to find the best or least expensive product or service for customers.
“The proposal put forth by the SEC is no more than ‘fiduciary light,’ which will not protect the consumer, but will give the industry plenty of cover from potential lawsuits,” Galvin said.
The fact that the SEC’s proposal limits the application of the best-interest standard to the moment when a broker makes a securities transaction for a customer heightens state securities regulators’ concerns. “Any best-interest standard imposed on broker-dealers must be applied as broadly as possible under the securities laws and must become operative early in the client relationship,” Borg said. “Allowing broker-dealers to otherwise limit the application of the heightened standard to any of the services they provide will only serve to diminish the important protections to be gained with the implementation of a heightened standard of care.”
The SEC proposal fails to state that sales contests and sales quotas are fundamentally inconsistent with the best-interest standard, making it inconsistent with investor best interests, Galvin added.
The issue of contests is a hot button for the Massachusetts regulator, who charged discount broker-dealer Scottrade in February with allegedly violating fiduciary standards by using sales contests to encourage aggressive sales practices. Scottrade was acquired by TD Ameritrade last September.
“An investor’s life savings should not be caught up in a contest to win a trip or other award,” Galvin said.
Galvin pointed to real-life examples of investors who have lost billions of dollars as a result of conflicted investment advice by listing numerous enforcement actions his office has taken. Massachusetts has recovered millions of dollars in losses for investors, caused by brokers making conflicted investment recommendations, promoting high-fee and high-commission products and making fraudulent representations in order to induce investors to stay in poorly performing investments, he said.
Galvin urged the SEC to replace the current proposal with a meaningful one that will put brokers on equal footing with investment advisors.
“As a regulator, I have seen the grievous harm suffered by Main Street investors who mistakenly trusted and relied on conflicted investment advice. The commission now has the opportunity of a generation to protect them. If they fail to do so, it will be left to the states,” Galvin said.
