Why the SEC Proposal Is a Victory for Clients

As Seen in On Wall Street

By John Taft, Vice Chairman of Baird

The new proposed advice rules from the U.S. Securities and Exchange Commission (SEC) represent by far the most constructive step forward in the eight years since the Dodd-Frank Act debate over the best way to enhance protections for individual investors.

In opening remarks at a historic public meeting Wednesday, SEC Chairman Jay Clayton articulately highlighted the challenges of balancing client access and choice with enhanced protection for individual investors.

The SEC’s proposed regulatory framework, which moved forward in a 4-1 vote, abandons Dodd-Frank’s vision for a uniform fiduciary standard across all types of financial advisors and business models in the wealth management industry. And it explicitly avoids using the word fiduciary.

But in its place, the commission proposes a thoughtful and considered approach to applying underlying fiduciary principles to an area of the financial advice industry that has never before been subject to those principles – namely, the brokerage industry.

It does so in a way that recognizes that market forces and individual preferences – not regulation – should determine what products and services investors use, what firms and advisors they work with, and how they pay for those services. It also relies on broad principles, rather than the detailed and intricate ERISA-type rules the U.S. Department of Labor tried, unsuccessfully, to overlay onto the brokerage industry.

In writing its framework, the SEC explicitly recognizes the fact that commission-based transaction services can be the most cost effective way for main street investors to receive financial advice, welcome words after years of the Labor Department’s vilification of commission-based brokerage accounts.

The SEC’s framework requires that “broker-dealers making a recommendation to a retail customer would have a duty to act in the best interests of the … customer, without putting the financial or other interests of the broker-dealer ahead of the retail customer.”

It requires that broker-dealers discharge that duty in three ways:

• By disclosing to customers, through a standardized four page “Customer Relationship Summary,” key facts about individuals’ relationships with the advisor and the firm they work with, particularly with respect to material conflicts of interest;
• By exercising “diligence, care, skill and prudence” when it comes to determining that a product or a service is in the customer’s best interest; and
• By establishing, maintaining and enforcing policies and procedures to identify, mitigate and in some cases eliminate material conflicts of interest, especially those arising from financial incentives.

One of the most controversial parts of the proposal is likely to be a prohibition against using the title of advisor (as in financial advisor or wealth management advisor) unless a financial professional is acting as a fiduciary under the Investment Advisors Act of 1940. The SEC’s rationale for this titling provision – which insiders suggest was necessary to get a majority of the commission to vote for the new regulation – is that the word advisor is so closely identified with the fiduciary requirements of investment advisors that it creates confusion for investors when used by anyone other than an investment advisor.

The SEC’s proposal is far from perfect. Fiduciary purists and other critics will get their chance to recommend modifications during a 90-day comment period. Among other things, it leaves investors and wealth management practitioners with a complex and fragmented regulatory regime: ERISA for qualified plans, the Investment Advisors Act for discretionary investment advisory services; and the new Regulation Best Interest for brokerage activities.

But this is not the time to let the perfect be the enemy of the good.

If and when the SEC proposal becomes effect, we will finally have a principles-based requirement that in every interaction with an individual investor, financial professionals will need to put the interests of the client ahead of their own.

That already reflects best practices in the wealth management industry.

Eight years after Dodd-Frank gave the SEC the authority to act, the commission has finally offered up the critical missing piece in what Chairman Clayton called “a comprehensive path forward” towards restoring investor trust and confidence. Importantly, it has proposed to do so in a way that preserves investor access to the products and services they enjoy today, and investor choice as to who they work with and how they pay for those services.

John Taft is Vice Chairman of Baird. He is a past chairman of the Securities Industry and Financial Markets Association (SIFMA), where he advocated for responsible financial reform. He is the author of two books, “Stewardship: Lessons Learned from the Lost Culture of Wall Street” and “A Force for Good: How Enlightened Finance Can Restore Faith in Capitalism.”