POINT OF VIEW: DOL Fiduciary Rule DOA, SEC Steps Up

By: William R James, Senior Content Specialist
April 8, 2019
financial advisor meeting with married couple clients to discuss options

Disclaimer: William R. James is a Senior Editor at Kaplan Financial Education. The opinions expressed in this article are solely those of the author based on personal research and observations. They should not be viewed as legal advice.

Commission Approved Best-Interest Proposal for Brokers

The continuous effort to roll back and stall the Department of Labor’s fiduciary rule by the Trump White House and a sizeable number of influential plaintiffs winning in circuit courts finally worked. Last month the DOL told CNBC, following an order by the Fifth Circuit to vacate, that pending further review it will not be enforcing the 2016 fiduciary rule. With the SEC Commissioners 4-1 approval of its “best interest” proposal on April 18, it appears that the final nail was hammered into the coffin of the Obama-era DOL’s effort to regulate certain advice to pension funds.

The 1,000-page DOL proposal was the sum of years of effort to reign in and regulate the retirement plan advisory business provided by brokers. However, both the Fifth and Tenth Circuits found it wanting, ordering the DOL to vacate the rule, declaring it unreasonable—that it constituted "an arbitrary and capricious exercise of administrative power.” The Department of Labor’s reach by looking to transform and regulate in entirely new ways many thousands of financial services providers and insurance companies for retirement plans, falls outside of what is reasonable. Stepping up quickly, the SEC announced its own long-anticipated alternate rule. Known as Regulation Best Interest, the Commission took a decidedly different approach.

SEC Chairman Clayton voiced the concern of many that there needs to be “clarity and harmony to investment advisor, broker-dealer standards of conduct.” SEC Commissioner Michael Piwowar, who along with Clayton voted in favor of the Best Interest proposal declared it to be “a solid building block...it imposes a new best-interest standard.” While he noted that he has some misgivings, he added, “No longer can people say the SEC needs to do something about this [standard of conduct].” During the obligatory 90-day comment period, Piwowar is hoping to hear comments as to whether the new regulation increases compliance costs for broker-dealers. Commissioner Robert Jackson stated the “need for SEC action has been even more urgent.”

The Bullet Has Been Bitten

I think it’s safe to say without being hyperbolic, that the dollar figure spent by the brokerage industry to comply with a now lifeless rule is staggering. A SIFMA study put the number at $4.7 billion in start-up costs to comply with the anticipated DOL rule. With that investment, it’s not surprising that sizeable broker-dealer advisors look to hang on to the momentum and get something for their money, particularly since they were moving in the fiduciary direction in the first place, seeing it as the business model of the future regardless of what happened to the DOL rule. They’ve bitten the bullet, done a lot of work, and aren’t looking to change anything at this point. Though admittedly, no one can suppress a smile knowing that the specter of class-action lawsuits, no matter how watered down by exemptions or private right of action, no longer looms.

The Commission’s best-interest rule drubbed out the legal ax that hung over the necks of broker-dealers and their associated persons who failed to pick up the nuances of the DOL’s fiduciary rule. The DOL provided a path for customers to sue brokers in class-action lawsuits. The SEC-proposed rule has no such blade in it, suggesting to careful readers that FINRA’s Code of Arbitration will remain the backbone to dispute resolution. I expect disciplinary action will find a way into further review during the 90-day comment period on the new rule.

Working more closely in a fiduciary capacity, including a clear explanation of investments and fees with customers, is a path that works with the fiduciary and best interest standards. The suitability standard is still in play, but its days are numbered by rule and business practice. Bulge-bracket and RIA firms were acting as fiduciaries well before the DOL launched its rule, and those that were gearing up for it will continue as though the Fiduciary Rule was still in force.

Belying the Commission’s nearly 1,000-page proposal that suggests to the mind a comprehensive, batten down the hatches, weighty rule, it appears to offer a gentler approach than the DOL. By proposing a uniform standard of conduct for broker-dealers and advisers in light of their different relationship types and models for providing advice, the Commission offers a deft touch to regulation. Brokers would be required to disclose conflicts of interest and look to eliminate or “mitigate” them, but the Commission does not intend to require brokerages to mitigate every material conflict of interest. That means the door is still open for a carefully applied sales contest. The SEC has stated that, “We do not intend for our standard to prohibit a broker-dealer from having conflicts when making a recommendation."

Reawakened Market Participation

With this somewhat more relaxed approach, the door may hopefully swing the other way, offering significant players that earlier withdrew from the market of servicing retirement investors due to the DOL’s heavy-handed approach a way and desire to get back in. It is possible these former players may reconsider their departure. I hope so.