In Whose Interest Is SEC `Best Interest' Broker Rule?: QuickTake

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(Bloomberg) -- What standard should apply to brokers who advise their clients on what to buy? President Donald Trump’s administration, like that of Barack Obama’s before it, is grappling with how to discourage sales practices that steer customers into investments that boost broker compensation but are inappropriate for the client. The latest idea -- a "best interest" standard -- comes from the U.S. Securities and Exchange Commission. Already, it’s causing confusion.

1. What does ‘best interest’ mean?

Lots of people are wondering that. In a proposed rule that runs more than 400 pages, the SEC says it wants broker-dealers "to act in the best interest of the retail customer" but adds, "We are not proposing to define ‘best interest’ at this time.’" Instead, the agency lists "obligations" of brokers to ensure they don’t place their own interests before those of their clients, and says firms must “establish, maintain and enforce policies” that are designed to spot and mitigate conflicts.

2. Will this work?

That remains to be seen. By a 4-1 vote, the five SEC commissioners, including Chairman Jay Clayton, released the proposal for a 90-day public comment period. But Republican and Democratic commissioners expressed concern that the agency had left things too vague. It’s safe to assume the final version of the rule will have significant changes, but that the "best interest" standard is likely to remain at its core.

3. What standard are brokers currently held to?

Brokers have long been held to a "suitability" standard -- meaning, they must make recommendations that are suitable to a particular client’s financial situation. Investment advisers are held to a higher standard, the fiduciary duty, which means they must commit to putting the client’s interest first and charging reasonable compensation. The Obama administration tried to extend the fiduciary obligation to brokers who handle retirement accounts, but that effort is stuck in legal limbo. A best interest standard for brokers, in practice, would likely fall somewhere between suitability and fiduciary.

4. What happened to the Obama-era rule?

After it was issued by the U.S. Labor Department in 2016, Wall Street firms argued that it could make professional advice too expensive for millions of households. Nonetheless, the bulk of the rule took effect on June 9, 2017, after a delay ordered by Trump. But the fate of the rule has been uncertain since March, when a federal appeals court struck it down as a "regulatory abuse of power." It’s unclear if the Labor Department will challenge the appeals court’s decision; in case it doesn’t, three states are seeking court approval to take up the battle for the fiduciary rule. Either way, with the Labor rule at least delayed in court, many in the industry expect the SEC’s "best interest" standard to become the law of the land.

5. Who enforces these standards?

The Financial Industry Regulatory Authority, or Finra, a self-regulatory organization overseen by the SEC, is largely responsible for holding brokers to the current "suitability" standard and can issue fines, suspensions or bars against firms or individuals who violate it. Finra would probably shoulder the brunt of responsibility for enforcing the SEC’s proposed "best interest" standard as well. Crucially, the fiduciary rule, if revived, would give aggrieved customers the right to bypass Finra’s arbitration process and sue brokers who handle retirement accounts.

6. Why all this attention to broker behavior?

The Obama administration concluded that brokers were boosting their compensation by pushing clients into high-fee products instead of better alternatives, costing customers $8 billion to $17 billion a year in higher fees and lower returns. Consumer groups concerned over the potential for conflicts of interest had long pushed lawmakers and regulators to hone in on the $14 trillion industry, particularly sellers of annuities. The SEC, in its recent proposal, concurs that brokers are inherently conflicted because the more a customer trades, the more commission money flows to the broker. But the SEC says it doesn’t want to overhaul the industry and "prohibit a broker-dealer from having conflicts when making a recommendation." Instead, its approach is to force brokers to disclose more and avoid recommendations that clearly benefit brokers at the expense of their clients.

7. How have financial firms reacted to the SEC’s proposal?

Mostly with quiet relief. The plan would probably force banks to spend money to comply with the new disclosure and conduct requirements. But that’s a small price to pay for another nail in the coffin of Labor’s dreaded fiduciary rule.

8. Haven’t some firms already adopted the fiduciary standard?

Yes, and some of those broker-dealers, banks and insurers might not want to go back, having started to promote their greater transparency and lower fees. American International Group Inc. and MetLife Inc. are among companies that already struck deals to sell broker-dealer units, to limit conflicts within their business.

The Reference Shelf

  • Read the full SEC "best interest" proposal.
  • The proposal would "leave a lot to the broker’s judgment," writes Matt Levine in Bloomberg View.
  • A look at how the fiduciary standard became a presidential issue for Obama.
  • What three professors found about advisers’ behavior.
  • A report from President Obama’s White House on the reasons for implementing the fiduciary rule.

©2018 Bloomberg L.P.

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