21 July 2019

SEC Votes For Stricter Broker Standards

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Stockbrokers would face tighter restraints on conflicts that can bias investment advice to customers, under a rule proposed Wednesday by the Securities and Exchange Commission.

The SEC’s plan to require brokers act in the best interest of clients is less restrictive than the Labor Department’s “fiduciary rule” affecting retirement accounts that was completed during the last days of the Obama administration, and will likely spark complaints from congressional Democrats and consumer groups that it is too permissive. The SEC’s rule wouldn’t ban any single conflict of interest, such as sales contests that brokers conduct to juice sales of particular products, but would generally require brokers to disclose conflicts of interest and try to blunt their impact.

The SEC’s rule, approved Wednesday by a 4-to-1 vote and sharply criticized by the agency’s Democratic members, could eventually replace the fiduciary rule. A federal appeals court last month overturned the Labor Department regulation after a lawsuit by Wall Street trade groups.

The SEC proposal “reflects a multipronged effort to fill the gaps between investor expectations and legal requirements, increasing investor protection and the quality of advice while preserving investor access and investor choice,” SEC Chairman Jay Clayton said.

The proposal will now be subject to 90 days of public comment. The SEC will need to vote to finalize the rule after studying those comments.

Wall Street hopes the SEC’s proposal provides it flexibility to continue selling some higher-fee products and serving smaller investors by charging them commissions. The Labor Department’s rule made it harder for brokers to charge commissions and sell some higher-fee investments, which the industry said reduced choices for investors.

Under the SEC’s proposal, brokers would generally be required to disclose conflicts of interest to clients such as bonuses they get for selling certain products or fees they earn for steering investors toward certain mutual funds or insurance products. Brokers also would have to either blunt the impact of the worst conflicts or eliminate them entirely.

Certain incentives such as sales contests, or prizes brokers get for selling certain investments, would probably be untenable under the rule, according to people familiar with the SEC’s thinking.

The Obama administration said conflicts of interest cost retirement investors $17 billion a year, a figure the securities industry disputed.

The SEC plan also requires brokers to apply special scrutiny when they recommend a series of trades that would generate more income for the firm. The measure is intended to make it harder for brokers to “churn” accounts, or make nonsense trades that simply generate commissions for the broker.

SEC Commissioner Kara Stein, the lone vote against the plan, blasted the proposal as a failure to upgrade current requirements on brokers to provide advice that is suitable to clients. Ms. Stein, a Democrat, said the SEC didn’t even define what “best interest” means, giving brokers room to rely on arcane disclosures and policies to escape liability. Her rebuke of the plan will signal to congressional Democrats that they should oppose the measure and aggressively question Mr. Clayton about it.

“Despite the hype, today’s proposals fail to provide comprehensive reform or adequately enhance existing rules,” Ms. Stein said. “Perhaps it would have been more accurate to call it ‘Regulation Status Quo.’”

Other commissioners, despite voting for the plan, criticized elements of what the SEC put forward on Wednesday. That could make it harder to finalize a rule in the coming months, since commissioners are less willing to support final rules they believe are flawed. Republican Commissioner Michael Piwowar said the proposal could more clearly explain what brokers have to do to show their advice was in the “best interest” of investors.

“This lack of clarity is worrisome and could undermine our goal of preserving retail investors’ ability to access different types of financial services,” Mr. Piwowar said.

The SEC proposal also doesn’t create a new basis for investors to sue their brokers for violating the best-interest standard. That means investor complaints will still be decided in arbitration hearings organized by the Financial Industry Regulatory Authority, an industry-funded regulator. Wall Street revolted against Labor’s rule because it created a way for clients to sue brokers in class-action lawsuits.

The distinction between brokers and investment advisers has long confused many retail clients. While brokers earn sales commissions, advisers are paid a fee that is set as a fixed percentage of a client’s assets. Advisers’ payment model is supposed to free them from pushing particular products and instead focus on managing a well-performing portfolio.

The SEC’s proposal would require brokers and advisers to produce a short brochure that explains the different legal duties and the fees they may charge. Separately, the SEC proposed barring brokers from using titles, such as “financial adviser,” that blur the line between their business model and the fiduciary duty that binds investment advisers.

Mark Flannery, a former SEC chief economist, said the new disclosure might be helpful to some investors, but for others it will be too generic to give them any bargaining power. A better way to arm investors, which he proposed to the SEC in July 2017, would be requiring brokers and advisers to periodically send clients a report that details all of the fees they paid—to their broker, the broker’s employer, and others who make money off their investment choices.

“When people know what they are paying, there will be pressure for fees to come down,” said Mr. Flannery, now an economist at the University of Florida.

Click here for the original article from The Wall Street Journal.

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