By Amanda Maine, J.D.
Several organizations have written letters to the SEC commenting on its proposed Regulation Best Interest (Reg BI) and related proposals regarding investment advice professionals’ standards of conduct at the close of the comment period last week, including the Investment Company Institute (ICI) and the Securities Industry and Financial Markets Association (SIFMA). Both organizations were largely supportive of the SEC’s proposals, but described areas in need of improvement or clarification.
ICI. In its letter, ICI emphasized the importance of coordinating with the Department of Labor so that DOL explicitly recognize the SEC’s best interest standard once formally adopted. In addition, the ICI urged the SEC to explicitly affirm that its standards of conduct would preempt any state law standards of conduct inconsistent with the SEC’s.
ICI requested that the SEC specifically confirm that the proposed disclosure obligation on the scope and terms of a customer’s relationship with a broker-dealer and the broker-dealer’s incentives do not require the broker-dealer to separately calculate fund fees and expenses. According to ICI, funds are currently required to provide comparable, standardized fee disclosure, which is a better approach than requiring brokers to independently calculate fund fees. Not only would providing individualized cost disclosure be challenging and extremely costly for broker-dealers, this overemphasis on cost could discourage broker-dealers from recommending funds that offer investors other important benefits, ICI warned. Instead, funds should be allowed to direct customers to the detailed, standardized information about fund fees and expenses in the fund prospectus, rather than independently calculating fund fees.
ICI also advised that the SEC tailor its proposed conflicts of interest obligations on broker-dealers that recommend proprietary products to require that broker-dealers have policies and procedures reasonably designed to: (1) identify and disclose material conflicts of interest associated with such recommendations; and (2) mitigate or eliminate those material conflicts of interest that create a financial incentive for the broker-dealer representative. This approach would be consistent with that of the DOL under its now-vacated fiduciary rule and focuses on the representative’s conflict of interest, according to ICI.
In addition, ICI urged the SEC to adopt a single definition of “retail investor” for its rulemakings under Reg BI and proposed Form CRS and limit that definition to natural persons. ICI also recommended that the SEC refine its interpretation of an investment adviser’s fiduciary duty to be more consistent with existing law, including an acknowledgment that institutional advisory relationships can differ from retail advisory relationships. Finally, ICI advised that the SEC not incorporate certain broker-dealer rules into the regulatory framework for investment advisers.
SIFMA. SIFMA commended the SEC for its proposals which the Association believes will protect retail investors while preserving retail investor choice and access to the brokerage “pay as you go” advice model. However, it outlined certain changes that the SEC should incorporate into its final rulemaking. Regarding proposed Reg BI, SIFMA recommended that the definition of “retail customer” be harmonized with FINRA’s definition because the definition as proposed would result in inconsistent and redundant compliance structures.
SIFMA also urged the SEC to incorporate the “reasonable investor” definition of materiality set forth in Basic v. Levinson (U.S. 1988) into its interpretation for “material conflicts of interest” to ensure only meaningful disclosures, and not excessive disclosures that could overwhelm investors under the SEC’s proposed definition. By focusing on the significance a reasonable investor would place on withheld or misrepresented information, the SEC would promote consistency with the rest of the Exchange Act and achieve the SEC’s goal of meaningful disclosure, according to SIFMA.
In a similar vein, SIFMA stated that the conflict of interest obligations should not distinguish between financial and non-financial conflicts of interest, but instead whether the conflict is material. SIFMA feels that a distinction between the two is not meaningful, given that virtually all conflicts of interest have a financial motivation, even if attenuated.
Regarding the relationship summary under proposed Form CRS, SIFMA advised the SEC to adopt a simplified, less confusing, and more flexible approach to disclosure. Specifically, SIFMA objects to a “one-size-fits-all” Form CRS, citing concerns facing dually-registered broker-dealers/investment advisers. According to SIFMA, the proposed dual-registrant Form CRS would confuse investors by presenting information that may not be relevant to them. SIFMA’s letter includes two mockup Forms CRS reflecting possible approaches the SEC can take in making Form CRS more flexible.
While SIFMA urges the SEC to move forward without delay on finalizing its standards of conduct rules, it advised that compliance with the final rules fall under an implementation period of at least 24 months. Firms will need sufficient time to implement training programs and develop extensive infrastructure and systems to comply with whatever rules of conduct are eventually adopted, SIFMA explained.