Financial Institutions Law Alert

The House Financial Services Committee Chair Lays Out Her Plan for Financial Reform. 

President-Elect Joe Biden is quickly learning that the line of people seeking regulatory reform in the wake of the Trump administration's regulatory free-for-all is getting longer all the time. At the front of the line is Congresswoman Maxine Waters (D-California), the House Financial Services Committee chair, who penned a 45-page letter in early December, which argues for a complete reversal and re-tooling of Trump-era financial regulation.

While it should come as no surprise that an incoming democratic administration seeks to tighten the screws on Wall Street just as easily as the outgoing republican administration sought to loosen them, what Waters is asking for, at first blush, seems counter-intuitive.

Among many other items on her wish-list, Waters presses the new administration to overturn Reg. BI (including form CRS), the regulatory juggernaut that has had the industry scrambling to build compliance systems since its adoption in June 2019.

Reg. BI became effective on June 30, 2020, and requires brokers to recommend investments strictly in the client’s best interests, stretching well beyond FINRA Rule 2111, which requires advice to be merely "suitable."

While a rule that requires a “best-interests” standard seems fair and equitable, the reality of Reg BI is far more demanding. The full text of the regulation requires broker-dealers to "act in the best interest of the retail customer at the time the recommendation is made, without placing the financial or other interest of the broker-dealer ahead of the interests of the retail customer; and address conflicts of interest by establishing, maintaining, and enforcing policies and procedures reasonably designed to identify and fully and fairly disclose material facts about conflicts of interest, and in instances where we have determined that disclosure is insufficient to reasonably address the conflict, to mitigate or, in certain instances, eliminate the conflict.”

Reg. BI applies not only to current retail clients but potential ones as well. If a potential client, as a result of a recommendation, opens a new account, that recommendation is subject to the rule.

The new rule seems like a lot for the industry to swallow, so why is Waters asking Biden to take an eraser to it? Because she believes it doesn’t go far enough.

Waters seeks the imposition of a broad fiduciary standard, which has been in the works since 2010 when President Obama’s Labor Department promulgated the dreaded “DOL” standard for investment advice. The DOL rule sent shockwaves through the industry until it was withdrawn in 2011 in the face of intense pressure and finally killed in 2018 when a federal appeals court struck down the rule's 2016 version.

Writing for the majority, Circuit Judge Edith Jones, a 1985 Regan appointee, said the Labor Department acted unreasonably in expanding a 40-year-old definition of “investment advice fiduciary.”

With the DOL rule dead, enter SEC Chairman Jay Clayton, who, in June 2019, heralded the new Reg. BI as substantially enhancing the broker-dealer standard of conduct “beyond existing suitability obligations.”

Waters was not buying it. In a June 5, 2019 statement, Waters argued, “The SEC’s final rule ignores the explicit will of Congress and fails to require all financial professionals to abide by a strong, uniform fiduciary standard of care when providing investors with investment advice…” she goes on to say, “… this rule could lower the standard that investment advisers currently abide by and mislead investors into thinking that brokers who comply with this new rule are putting their clients’ interests first."

Waters was not alone. In his public statement made at the same time, democratic SEC Commissioner Robert Jackson assailed the 3-1 vote approving the measure as failing the average investor by bypassing investment advisors all together and governing brokers with a “weak set of measures that are unlikely to make much difference.”
Waters and Jackson make some interesting points. While Reg BI is heavy on mandates, it is light on the number of people it covers. It also doesn’t help that the drafters of a “best interest” rule didn’t even bother to define "best interest," which leaves the rule open to broad interpretation. It’s a fair question whether regulators or FINRA arbitrators will be able or willing to differentiate the new rule from the familiar suitability standard.

The fiduciary standard currently only applies to brokers who have discretion and RIA’s, who are bound by their own fiduciary standard via the Investment Advisers Act of 1940. While Reg BI applies to all brokers, no matter what level of discretion they have, it is still a lesser standard, so the non-discretionary client does not get the benefit of the greater fiduciary standard and is left to figure out on their own which advisor is covered by what rule.

For those industry professionals who have sat through Reg BI training and still can't figure out the difference between Reg BI and the Form CRS requirement, Waters might ask if it is fair to ask the investing public to do the same.

The real question is whether Biden will bother to burn the political capital necessary to get a broad, industry-wide fiduciary standard on the books? No matter what congress looks like in 2021, the industry will push hard and fast against it, just like DOL.

History is not on Biden’s side. Having seen President Obama’s DOL efforts going up in flames first at the hands of the industry and then the courts, why would Biden push a fiduciary standard when there are so many other places to plant the flag for progressive legislators clamoring for his attention?

So, where do we go from here? What does the industry do, having expended all the time and money on building compliance systems and training thousands of people? The answer is simple: don't throw out all of those Reg BI power-points and manuals just yet. There is no question that Maxine Waters will fight to get what she wants. The question is, will she win?

The analysis contained herein does not constitute legal advice and is for informational purposes only. Any opinions or statements by the author are his own and do not necessarily reflect the views of Bressler, Amery & Ross.

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