Much has happened since we last reported on the Department of Labor’s Fiduciary Rule. The compliance deadline was extended 18 months to July 1, 2019. A federal appellate court vacated the Fiduciary Rule in its entirety. The U.S. Securities and Exchange Commission finally issued its own proposed “best interest” standard for brokers. And several state legislatures, frustrated by the lack of progress at the federal level, have picked up the baton of reform with their own proposals.

These efforts – aimed at bringing more clarity and transparency to the industry – continue to create confusion for investment professionals and clients, and to raise challenging questions both legally and politically about whether and how to protect investors while preserving their access to a range of investment products and services.

The DOL Fiduciary Rule

The DOL’s Fiduciary Rule was originally scheduled to be phased in from April 10, 2017, to January 1, 2018. When President Trump took office, he issued a memorandum asking for a review of the Fiduciary Rule, including an economic and legal analysis of its potential impact. This prompted the DOL to consider delaying implementation of the Fiduciary Rule. The DOL solicited input during a brief public comment period, after which, it officially delayed implementation by only 60 days. It cited concerns that further delay would contradict previous findings of ongoing injury to retirement investors. While the DOL stated publically that the Fiduciary Rule would not be delayed beyond June 9, 2017, it reopened the public comment period for another 30 days on June 30, 2017. A few weeks later, the DOL proposed an 18-month delay to the Fiduciary Rule’s compliance deadline. The delay was approved, shifting the final deadline for compliance from January 1, 2018, to July 1, 2019.

This long path toward full implementation of the Fiduciary Rule took another detour on March 15, 2018, when the U.S. Court of Appeals for the Fifth Circuit sitting in New Orleans vacated the Fiduciary Rule in its entirety. The Chamber of Commerce, along with several other interested industry groups and national associations, sued the DOL on grounds that it exceeded its authority in promulgating the Fiduciary Rule. Writing for the majority, Circuit Judge Edith Jones held that the DOL acted unreasonably, arbitrarily, and capriciously in expanding a 40-year-old definition of “investment advice fiduciary,” and therefore, was not entitled to the deference typically shown to federal agency action. She added that it was “not hard to spot regulatory abuse of power when an agency claims to discover in a long-extant statute an unheralded power to regulate a significant portion of the American economy.”

After the ruling, the DOL stated that it would not enforce the Fiduciary Rule pending further review. It had until April 30, 2018, to appeal the Fifth Circuit’s decision to the U.S. Supreme Court. Because it chose not to take action, the Fiduciary Rule will cease to have effect when the Fifth Circuit issues its mandate sometime in mid-May. It was not at all certain that the U.S. Supreme Court would have granted certiorari because there is not a clear split among the Circuit Courts of Appeals.

The Fifth Circuit’s decision could have a broader impact beyond just the DOL’s efforts to impose a fiduciary duty on brokers. Its ruling rested squarely on the long-recognized distinction between ordinary sales conduct and investment advice, the latter giving rise to heightened duties based on the existence of a special relationship of trust that is the hallmark of a “fiduciary” under the common law. That same rationale would apply to efforts by the SEC and state legislatures to impose heightened standards on the brokerage industry to protect investors and to mitigate conflicts of interest.

The SEC’s Regulation Best Interest

On April 18, 2018, the SEC voted 4-1 in favor of releasing its package of proposed rulemakings and interpretations, which according to an SEC press release, are “designed to enhance the quality and transparency of investors’ relationships with investment advisers and broker-dealers while preserving access to a variety of types of advice relationships and investment products.” Many have speculated that the SEC felt compelled to accelerate hitting this milestone – eight years in the making – in response to the Fifth Circuit’s ruling.

While it might seem absurd to call something that has taken eight years to complete “rushed,” that was the reaction by many stakeholders, including Commissioners on both sides of the political aisle. Even SEC Chairman Jay Clayton acknowledged that criticisms of the proposal “effectively illustrate the complexities we face as we move forward” toward a final set of rules, and “represent the need for public comments.”

Republican Commissioner Hester Peirce expressed her reservations that the proposed “best interest” standard of conduct for broker-dealers was an impossible standard that needs more clarity because “whether a particular recommendation is in a customer’s best interest is a value-laden judgment.”

Under the proposed Regulation Best Interest, a broker-dealer making a recommendation to a retail customer as to any securities transaction or investment strategy involving securities would have a duty to act in the “best interest” of the retail customer at the time the recommendation is made, without putting the financial or other interest of the broker-dealer ahead of the retail customer. By design, this falls short of the DOL Fiduciary Rule’s stricter fiduciary standard and attempts to maintain the distinction between broker-dealers and investment advisers in light of their different relationships with clients.

The term “best interest” is not defined. Instead, the SEC offered guidance as to how broker-dealers may comply with the new standard: disclose to retail customers the key facts about their relationship, including material conflicts of interest; exercise reasonable diligence, care, skill, and prudence to form a reasonable basis to believe that the investment recommendation is in the retail customer’s best interest; and to establish, maintain, and enforce policies and procedures reasonably designed to identify and to mitigate conflicted financial advice.

It is not clear how the “best interest” standard differs from the suitability standard that applies to broker-dealers now, or how broker-dealers can be certain that they satisfy the compliance requirements without more clarity on what it means to mitigate conflicts in a particular situation.

The SEC’s proposal also requires a new short-form disclosure document of no more than four pages with simple and easy to understand information about the nature of the relationship between investors and their investment professionals. This would be in addition to, not in lieu of, existing disclosure requirements, and would include disclosures about fees and costs. It is not the SEC’s intent, however, to prohibit broker-dealers from having conflicts when making recommendations.

The SEC’s proposal will be open for a 90-day comment period after its published in the Federal Register. The only consensus seems to be that a lot of work will have to be done to reach a consensus on the language of a final rule. Implementation of a final rule will not happen any time soon.

State Legislative Efforts

Several states are tired of waiting, and in recent months have enacted legislation or proposed regulations that require investment advisers to disclose conflicts of interest and/or to act in their clients’ best interests. A bill in New Jersey would require non-fiduciary advisers to disclose to clients that they are not required to act in the clients’ best interest. Nevada is drafting regulations to implement a law enacted in 2017, which imposes a fiduciary duty on brokers, sales representatives, and investment advisers who give investment advice. A proposed rule in New York would impose a best interest standard on sellers of life insurance and annuity products as investment vehicles. A Connecticut law already in effect requires administrators of state-run retirement plans to disclose certain investment fees and fees paid to investment advisers. The multiplicity of different standards at the state level, as well as concerns that they could run afoul of federal preemption laws, at least with respect to retirement advice, will likely only complicate matters.

In Maryland, opponents of a proposed fiduciary standard for brokers succeeded in having it removed from both the House and Senate versions of the Financial Consumer Protection Act of 2018. The proposed fiduciary duty language broadly defined anyone who engages in the business of effecting transactions in securities in a client account as a fiduciary “who has a duty to act primarily for the benefit of its clients.” It also would have required such fiduciaries to disclose, “at the time advice is given, any gain, profit or commission the person may receive if the advice is followed,” and to disclose disciplinary actions “material to an evaluation of the person’s integrity or ability to meet contractual commitments to clients.”

The Financial Services Institute, an advocacy organization representing independent broker-dealers and financial advisers, lobbied against both the House and Senate bills and argued that states should refrain from enacting their own laws or regulations that could conflict with the SEC’s proposal and make compliance difficult, if not impossible.

The Senate version of the bill, without the fiduciary duty language, directs the Maryland Financial Consumer Protection Commission to study the DOL’s Fiduciary Rule and SEC actions in dealing with conflicts of interest of broker-dealers through a heightened standard of care. Governor Larry Hogan has until the end of May to sign the bill into law or veto it.

Conclusion

These recent developments will not put an end to the debate over whether the brokerage industry needs heightened standards and disclosure requirements. Opponents and supporters of a fiduciary standard will battle on. Concerned that the DOL would not act by the April 30th deadline to appeal the Fifth Circuit’s decision, AARP and the Attorneys General of the States of New York, California, and Oregon filed motions to intervene requesting leave to file petitions for rehearing en banc. The Fifth Circuit denied those motions without an opinion in less than one week on May 2, 2018. The AARP is an ardent supporter of a heightened fiduciary standard for all investment professionals. Other industry groups have also come out in favor of a uniform fiduciary standard, including the Certified Financial Planner Board of Standards, Inc., the Financial Planning Coalition, and the National Association of Personal Financial Advisors.

The Financial Services Institute, Financial Services Roundtable, Insured Retirement Institute, and Securities Industry and Financial Markets Association stated that they would oppose any motion to intervene this late in the case. They did not have to because of the Fifth Circuit’s denials. The National Association of Fixed Annuities, which filed a separate lawsuit against the DOL in federal court in the District of Columbia, voluntarily dismissed its case in light of the Fifth Circuit’s ruling, stating that it vindicated its concerns and rendered its case moot.

Still, other interested parties think the best course of action is for the DOL to step aside and let the SEC take the lead. It has a broader statutory authority to regulate brokers than the DOL and was specifically tasked by Congress under the Dodd-Frank Act to determine what standards should apply to brokers and investment advisers.

In the end, state and federal regulators and legislators (and perhaps the courts) will have to grapple with the difficult task of providing a clear and practical set of rules that define an investment professional’s roles and responsibilities to clients if changes to the current standards are to be effective and efficient.