SPA conference: Panel debates over the merit of SEC’s best interest standard

By Emma Trincal

New York, Oct. 9 – The last morning’s panel of the 15th Annual Summit of the structured investment industry held in New York on Tuesday and organized by Mayer Brown and the Structured Products Association focused on one of the hottest regulatory topics of the moment: the future of the fiduciary standard for broker-dealers.

Entitled “update on regulation best interest, state fiduciary laws and the DOL fiduciary rule,” the discussion centered on the regulatory change that took effect in June when the Securities and Exchange Commission adopted a new fiduciary standard for the broker-dealer industry known as Reg BI for “regulation best interest,” replacing a much controversial one.

Controversial DOL

The original Department of Labor’s fiduciary rule, requiring brokers servicing retirement accounts to apply the tougher ERISA fiduciary standards, went through a slow death spiral in the course of three years, from its push in 2015 by president Barack Obama, to the rebellion that followed as the broker-dealer industry opposed the new standard. In 2017, the new Donald Trump administration required DOL to go back to the drawing board, putting things on hold. The ruling was dealt a final blow in court last year. As the DOL declined to appeal the decision to the Supreme Court, a page was turned at that point.

But are broker-dealers finally relieved after the disputed ruling was finally “killed” and replaced by one perceived to be less stringent? Panelists addressed this issue.

A new standard

The SEC rule requires broker-dealers to act in the best interest of their retail customers when making a recommendation. It imposes four obligations – disclosure, care, conflict of interest and compliance.

SEC chairman Jay Clayton said when the set of rules was adopted that the objective was to enhance the quality and transparency of retail investors’ relationships with broker-dealers and investment advisers and to increase investor protection.

“Importantly, they bring the legal requirements and mandated disclosures for broker-dealers and investment advisers in line with reasonable investor expectations,” Clayton said then in a speech.

The SEC also required broker-dealers to provide retail investors with Form CRS, which summarizes for investors the standard of conduct. The main purpose is to explain to investors the difference between advisers and brokers.

Looking better

Panelists discussed the impact of the new rule and whether it alleviated the regulatory burden and uncertainty created by DOL fiduciary.

The rule does not define best interest nor does it apply the existing Registered Investment Advisors (RIA) fiduciary standard to brokers, according to a legal update published by Mayer Brown. Brokers are not asked to make recommendations free of conflicts of interest but simply to enhance disclosure and reduce the impact of conflicts, the lawyers wrote.

“Reg BI brings better results than what we had. It’s a more efficient way to mitigate conflicts than the DOL standard,” Rafael Salvatierra, head of product structuring at Bank of America Merrill Lynch, told Prospect News.

Improvement for issuers

Panelists for the most part agreed with this view. But not all of them.

One panelist said the new regulation “was not trivial” and was not exactly a way to “get rid of DOL” as it still will have an impact on the financial industry’s compensation scheme. For instance, “customer-specific suitability” requirements would modify the “pay as you go” compensation model of brokers.

He also noted a lack of interpretation guidance, which may pave the way for an application of the rule through enforcement proceedings.

Marlon Paz, head of Mayer Brown’s broker-dealer regulation and compliance practice, agreed that there is a cost associated with adhering to customer-specific suitability standards, especially when the relationship has not been established for a long time.

For issuers though, regulation BI is an improvement, another panelist said.

The previous DOL fiduciary rule generated restrictions when the issuer and the underwriter’s selling syndicate were affiliated. Market participants and lawyers saw in this aspect of the rule a source of concern capable of having a negative impact on issuance depending on whether firms operated on an agency or principal basis.

“Regulation BI gives a lot of freedom to firms to continue to offer proprietary products to continue to operate as underwriters, which they couldn’t do before,” said Brad Busscher, chief administrative officer and general counsel of Incapital.

Still not ideal

Keith Styrcula, chairman of the Structured Products Association, painted a mixed picture when it comes to the overall regulatory environment.

“Structured products used to be on the radar of regulators. It used to be one of their top audits, It’s not so much the case anymore. Firms have hired a lot of lawyers and reinforced compliance. Our industry is no longer the regulators’ top priority because significant improvements have been made.”

On the fiduciary side however, the new rule is far from solving all problems faced by broker-dealers in his view.

“The regulatory scheme remains complicated. It’s out there. It’s ill-defined. Reg BI is superior to DOL but there is still a lot of explaining to do. The uncertainty is my biggest concern,” he said.

Lawsuits pending

Mayer Brown’s Paz told Prospect News that a lot indeed remained to be done.

“The firms that deal with structured products are big firms coming from a variety of segments or places from the broker-dealer side of the industry to the advisory side. You also have different regions from the U.S. to the European and Latin American markets.

“What standard will apply to them? There are still a lot of unanswered questions. This is a 700-page rule. There is not enough guidance. Firms are struggling to interpret those rules. It’s not clear how to implement this new standard.”

“Many of the states feel their customers are not adequately protected by the rules the SEC passed,” he added.

“How do you implement a rule that is subject to litigation between states and the SEC?”

Seven states and the District of Columbia are suing the SEC to overturn the rule.

Two of the states, New York and New Jersey, are heavyweight players in the financial services industry.

“The lawsuit is pending in NY. It’s going to be appealed. It might go to the Supreme Court,” he said.

Meanwhile, the interpretation of the rule is not easy.

“It is not clear what is a retail investor. And how do you define a recommendation,” he said.

“As a firm you have to comply with the rule, change your processes, change your documents, ask questions to the regulators while at the same time the SEC is in a lawsuit.”

Broker-dealers have a limited time to comply, he noted, pointing to the June 30, 2020 compliance date.

“There’s a lot to do. It’s a big deal.”

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