New Conflict-of-Interest Proposal Expected from SEC

As the Department of Labor (DOL) fiduciary rule process appears destined for defeat, experts speculate about the possibility that the SEC could take its own regulatory actions to address adviser conflict of interests; some say a new SEC rule could be proposed this week.

Serving today as chair of Goodwin’s ERISA and Executive Compensation Group, Scott Webster draws on more than 20 years of experience representing financial service firms and other fiduciaries, both preventing and helping to respond to disruptive litigation.

Webster’s background has included substantial work with clients responding to fiduciary breach claims regarding investment of retirement plan assets, including all manner of prohibited transaction matters. In addition, he has been extensively involved in establishing and operating collective investment vehicles, including group trusts, VCOCs and REOCs, as well as structuring and developing a variety of new investment products.

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Even with all that experience, however, Webster admits he is feeling just as uncertain about the long-term future of the Department of Labor (DOL) fiduciary rule process as the rest of us—thanks to the surprise decision last month by the Fifth U.S. Circuit Court of Appeals to vacate the core tenants of the DOL fiduciary rule expansion. This week, the Securities and Exchange Commission (SEC) is set to hold a meeting on the topic of whether to propose its own regulation pertaining to the definition of what constitutes fiduciary investment advice—this news coming while the DOL is still apparently contemplating whether it will accept the Fifth Circuit ruling, whether it will ask the Fifth Circuit for an “en banc” review of the decision, or whether it will ask for a direct appeal to the U.S. Supreme Court. Even for an expert attorney, Webster agrees it is not easy to keep all the moving parts in order. 

“Some analysts are suggesting that the SEC is ready to reveal language for its own fiduciary rule at the meeting that is going to be held on Wednesday this week, but I don’t think that’s the case, personally,” Webster says. “It is clear they are going to talk about proposing a rule, but my speculation at this point is that, they are more or less just going to talk about a rule. I would love to see language this week, but I suspect they are not that far along.”

Webster suggests there is reason to believe that the DOL and SEC have been coordinating fairly closely on this whole matter for some time now, and he agrees that there seems to room for real collaboration and even a spirit of teamwork emerging between DOL Secretary Alexander Acosta and SEC Chair Jay Clayton.

“The DOL has had their feet put to the fire here because of the relatively short window they have to formally respond to the Fifth Circuit decision,” Webster explains. “My sense is that the DOL may even be putting some friendly pressure on the SEC, to make it at least look like that process is moving along. This would in effect give some cover to the DOL, should that regulator decide to just let the Fifth Circuit decision stand. It will be easier for them to do this, politically speaking, if the SEC says at the same time that they are going to proceed with their own rulemaking.”

Asked to reflect on how the retirement plan and broader and investment advice industries reached this point of near-total uncertainty about the regulatory future, Webster agrees it has been quite a complicated and dramatic series of events leading to this week’s SEC meeting. And the unorthodox style and outlook of the Trump Administration, as Webster describes it, only adds to the number of possible outcomes here.

“Under any previous administration, Democrat or Republican, I would have virtually guaranteed to you that the DOL would appeal the Fifth Circuit decision, simply in order to defend its own ability to put forward and enforce new rulemaking, irrespective of the substance of the rulemaking in question,” Webster explained. “Under the Trump administration this is far from a given, and in fact I think it is appearing increasingly likely that the administration will not appeal the Fifth Circuit decision. I am not trying to criticize the president; it is just a fact that defending new regulation is not a priority.”

For that reason, Webster says it is “now very important to discuss what it means if and when the DOL fiduciary rule process dies out with the Fifth Circuit.”

“If the DOL rule dies in the Fifth Circuit, we return to the five-part test for determining whether advice is fiduciary in nature, and that could cause firms that have changed their practices after the DOL rule took effect in April 2016 to run afoul of the old rule,” he noted. “For example, this could happen in the case that a firm had changed its business model or perhaps just some aspects of its product set to take advantage of the Best Interest Contract Exemption, or perhaps another exemption coded into the DOL fiduciary rule. If the DOL rule goes away, of course, so will the exceptions. This actually could be fairly common, from what I have seen.”

Ultimately, during such uncertain times, Webster says the pressure is clearly on investment advice providers to monitor, more or less on a daily basis, where exactly the current regulatory framework stands. There is also the fact that multiple states are pursuing their own rulemaking regarding conflicted investment advice.

“We have been getting questions from independent fiduciaries left and right, asking whether they should be adhering today to the five part test or to the new DOL rule, and when they might have to switch again, and frankly the answer is not exactly clear at this juncture,” Webster concluded. “What is the DOL going to do? That is the question we first need to be answered. I don’t think they like the old five-part test, given that it was written decades and decades ago. You could even imagine a new rule coming out of the DOL, at some point.”  

Others expect SEC proposal to emerge imminently

Jamie Hopkins, Retirement Income Program Co-Director at the American College of Financial Services, also shared some commentary with PLANADVISER ahead of the SEC’s meeting this week. On Hopkins’ analysis, it appears “very likely” that the SEC will vote on Wednesday the 18th to release a specific new conflict of interest proposal.

“At this point, with all the talk, focus, work, and open meeting occurring that day, it would be a surprise if the proposed rule was note voted for by the committee,” he argues. “At that pace, we could see a rule on the SEC website within a week of the vote. However, this proposed rule might not end up looking anything like the final rule. Remember, the DOL proposed rule eight years ago ended up looking almost nothing like the final rule that was eventually passed and then vacated by the courts. So, expect the first proposed rule to be a starting point.”

Hopkins says he has heard some evidence that the SEC appears more willing to work with brokerage houses in “crafting a rule that does not destroy their business model or create significant backlash, but still moves the industry forward towards a more fiduciary like model.”

“But I do say ‘fiduciary like,’ as it appears that the SEC might stop a bit short of requiring everyone to adhere to a true and broad based fiduciary model,” Hopkins says. “Additionally, a SEC rule will change the landscape again, bringing a serious challenge from many interested parties. Some will likely complain the rule does not go far enough and others will challenge it as going too far. So don’t expect the proposed rule to be the end of the discussion, but merely a step towards rule making and a more-well defined fiduciary standard.”

Looking perhaps far ahead in the process, Hopkins speculates that in the end, a more unified Congress may have to weigh on the fiduciary status of financial advice before any true measure of lasting certainty can be established.

“The reality is that even the SEC’s avenue for rulemaking, while not as restricted as the DOL’s, is still restricted,” he concludes. “They will not be able to fully regulate all areas of financial advice as parts are outside their jurisdiction, so even in the broadest cast, this will result in a partial advice fiduciary rule.”

Brendan McGarry, an attorney at Kaufman Dolowich and Voluck who represents securities broker/dealers and registered investment advisers in litigation and regulatory matters, also expects language to be published soon by SEC. He says the SEC, from his vantage point, appears to be considering requiring broker/dealers to provide “what may eventually look like a simplified version of Form ADV, Part 2a, to their clients.”

“The content of such a disclosure remains to be seen,” McGarry explains, “but it appears the SEC may address purported concerns that broker/dealers and their associated persons, and their respective duties to their customers, may not always be fully understood by their customers. The SEC appears to be considering a uniform standard for broker/dealers and their associated persons in dealing with all retail customers, not just retirement investors.”