On June 5, the Securities and Exchange Commission adopted its long-awaited Regulation Best Interest (Reg BI). It mandates upgraded standards of conduct for broker-dealers, requiring, among other things, that any recommendations they make to retail customers be in the customers’ best interest. Five months later, the financial services industry is still trying to figure out how to implement the new regulation, which is expected to go into effect on June 30, 2020.
Confusion can be forgiven. Packed with footnotes, Reg BI is 1,363 pages long. It has generally been positioned as a win for broker-dealers and investment advisors relative to an earlier fiduciary rule from the Department of Labor. That rule was seen as more restrictive, but it was vacated by the 5th U.S. Circuit Court of Appeals in 2018.
Lindsay Jackson, a partner with the law firm of Morgan Lewis, says that at a high level, positioning Reg BI as a win for the financial services industry may be accurate. But she says it’s probably too early to say for sure.
It is true, Jackson said at the 2019 SVIA Fall Forum in Washington, D.C., that under Reg BI broker-dealers don’t face the same level of class-action risk they did under the vacated DOL rule. Nor is Reg BI as prescriptive. Still, she said, “there are a lot of open question about how this is ultimately going to be enforced by the SEC—and about what kind of enforcement actions, and the size of those actions, we could see in the future.”
Reg BI’s focus is on how the financial services industry treats retail customers, or “two-legged individuals,” added Daniel Kleinman, one of two Morgan Lewis partners who joined Jackson in discussing the new regulation. Accordingly, its direct impact on the stable value industry may be fairly limited, Kleinman said, perhaps coming into play when a retirement plan participant who has invested in a stable value product takes a distribution from their retirement savings account and is being advised on what to do with it. Nonetheless, he suggested the regulation is far-reaching enough that the stable value industry can’t afford to ignore it—especially in those instances where stable value is just one offering among many from a large financial services firm that may be interacting with customers on many different fronts.
Still, “this is an SEC rule, which means it deals with securities and the distribution of securities,” Kleinman said. “So financial assets that are not securities—that are insurance or banking product or commodities—aren’t covered by this rule unless they somehow trip the securities wrapper.”
One of the more complicated challenges presented by the new regulatory environment, Jackson said, revolves around its implications for full and fair disclosures to retail investors, and their informed consent to those disclosures, under the Investment Advisors Act of 1940. There’s a growing sense that in cases where a broker-dealer might have a conflict of interest so complicated that it can’t be adequately conveyed to a retail investor, the firm may have to take steps to mitigate or eliminate the conflict.
“To some extent, this may have some impact on stable value funds,” Jackson continued. “But I do think it puts some pressure on the people who are investing in stable value funds, too. Do they really understand what the conflicts are?”
Complicating the challenge of figuring out how to implement Reg BI, Jackson and Kleinman noted, is the fact that some states have challenged the regulation, and some are exploring the implementation of new rules of their own. At the same time, the DOL has indicated it is working toward introducing a new version of its vacated fiduciary rule. “I’m not so sure what happens if the SEC rule gets knocked out or vacated,” Kleinman said. “Then what happens? We’re back to status quo ante on both sets of regimes.”
Whatever happens, Kleinman stressed that at the root of all the debate is the decision by employers over the past few decades to effectively transfer the risk of financial loss for retirement assets to their employees, by largely replacing defined benefit pension plans with defined contribution retirement savings plans. “Now we’re questioning whether or not they (employees) have enough information, enough control, and enough products” to actually managing that risk effectively, he said. As part of that discussion, regulators are questioning whether simply making disclosures about complex investment issues and conflicts of interest to retirement plan participants is sufficient. They’re looking at whether those issues have been disclosed effectively, in a way that investors can actually understand them.
