What Should We Make of Regulation Best Interest?
The SEC has not gone as far as many would like, but it’s taken some important steps.
Controversy over regulators’ efforts to protect investors are nothing new. A few years ago, as the Department of Labor worked to finalize its “fiduciary rule” for retirement accounts, it often seemed like proponents and opponents of the rule were speaking a different language and drawing from a completely distinct set of facts. It should be no surprise then that, with finalization of the SEC’s new “Regulation Best Interest,” it seems again as though boosters and critics are describing completely different regulations.
The financial-services industry argues that the regulation is a step forward in protecting consumers, while breathing a sigh of relief at its overall scope. Consumer advocates have been arguing that the rule maintains the status quo and is less than useless because it will give investors a false sense of advisors’ obligations to them.
Who’s right? Everyone and no one.
In a nutshell, the rule will mean more protections for investors, but it will also further muddy the difference between the broker business model (which is based on commissions) and the Registered Investment Advisormodel (which is largely, although not always, based on charging a fee based on assets under management.) The rule also requires new disclosures on fees and conflicts of interest, which certainly will not help all investors. Still, these disclosures will inject more transparency into advisors’ business models, particularly because key disclosures will be publicly available and even machine-readable, allowing third parties to analyze them.
The final SEC rule is also stronger than the proposal in a few ways. First, it bans certain sales practices such as contests, quotas, bonuses, and noncash compensation to sell one investment over another in most circumstances. Second, it elevates cost as a consideration for brokers when they make a recommendation. This does not mean that brokers need to recommend the cheapest product, but they must at least consider cost when making a recommendation. Finally, the rule now explicitly covers account recommendations, so brokers recommending a rollover from a 401(k) will need to consider whether the rollover is in a client’s best interest compared with a workplace retirement plan.
Of course, for those looking for a rule that would upend the broker, asset manager, and advice business model--this is not it. Unlike the Department of Labor’s approach, this rule will not outright prohibit many conflicts of interest, such as revenue-sharing arrangements. (It will require brokers to mitigate these conflicts.) The Department of Labor would have also set up a private right of action for investors, making a potential class action lawsuit, likely leading to more-aggressive enforcement. Finally, the SEC choose not to incorporate the high standards of fiduciary conduct embodied in the Employee Retirement Income Security Act of 1974.
One thing that proponents and critics both have missed is that the SEC did not propose this rule in a vacuum. We have seen a long-term trend toward best-interest advice, and the proof is in the data. Every year, the asset-weighted average fee for mutual funds falls, while the average stays about the same. What does that mean? Investors are moving to lower-cost investment options, and advisors are increasingly working to help clients with asset allocation, long-term financial planning, and coaching them during downturns rather than pushing specific products.
Further, this rule comes on the heels of the Department of Labor’s rule, which spurred many in the industry to overhaul their businesses, even if the courts ultimately vacated the rule. Brokers looked at the funds they were selling and the allocation models they used to guide their recommendations and adjusted. Asset managers began to rethink how they wanted to distribute mutual funds, largely abandoning certain kinds of conflicted arrangements. Investors started asking their advisors questions about their conflicts and whether they acted as a fiduciary.
In summation, investors still cannot assume that the advice they get is conflict-free. But they will have protection from the most indefensible conflicts of interest and disclosures to help them understand how their advisor makes money. It’s not a radical shift, but it’s a real change.