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Proposed Rulemakings and Interpretations Relating to Retail Investor Relationships with Investment Professionals

April 18, 2018

Thank you, Chairman Clayton, and thank you to the exceptional Staff in the Divisions of Trading and Markets and Investment Management for their work on these proposals. As my colleagues have noted, today’s proposals have been decades in the making, and I am especially grateful to Director Dalia Blass and her wonderful colleagues Sarah ten Siethoff, Doug Scheidt, Sara Cortes, Holly Hunter-Cecil, Jennifer Porter, Emily Rowland, Jennifer Songer, Parisa Haghshenas, Benjamin Kalish, Roberta Ufford, Elizabeth Miller and Gena Lai, and our Trading and Markets colleagues Brett Redfearn, Lourdes Gonzalez, Emily Russell, Alicia Goldin, Bradford Bartels, Geeta Dhingra, Stacy Puente, and Roni Bergoffen for bringing these proposals before the Commission.

After years of tireless advocacy and relentless lobbying, the Commission today finally steps forward to propose a framework for protecting the millions of American families who rely on professional advice to save for education and retirement. The proposals offer a sliver of hope that the SEC will finally fill an enormous gap in our securities laws between the protections those families deserve and the legal obligations of financial professionals—a gap we have allowed to persist for far too long.[1]

Let me be clear: I could not support these proposals if we were today considering making them final agency rules. Commissioner Stein has explained the problems with the proposals far more eloquently than I can, and I point my colleagues to the thoughtful statement she issued today. Yet the need for SEC action in this area has been made all the more urgent by the Administration’s refusal to implement the crucial protections put in place by the Department of Labor in 2016[2] and the profoundly misguided recent judicial decision jeopardizing those protections.[3] I strongly support the Department of Labor’s rule because it protects investors from the very real costs of conflicted financial advice. But without an Administration willing to enforce it or courts willing to take the realities American families face seriously,[4] as we sit here today investors lack protections against so-called advisors who might endanger their financial future.

The Commission can and should provide the protections those investors so urgently need, so today I am reluctantly voting to open these proposals for comment—and to continue the conversation about how best to protect Americans’ financial futures from conflicted advice. I want to identify four areas where any final rule should be significantly improved—and urge commenters to help make sure that the work we begin today ends with nothing less than the common-sense protections investors deserve.

* * * *

First, the standard set forth in Regulation Best Interest is far too ambiguous about a question on which there should be no confusion: the duty that investors are owed by those who are entrusted with ordinary families’ economic futures. Americans deserve a clear best interest rule that places the client’s needs ahead of the broker’s. Period. There are, of course, many ways to write one—we could have, and should have, simply started with the standard Congress articulated in the Dodd-Frank Act.[5]

As written, the standard is potentially confusing, and I worry that it may be interpreted to permit conflicted advice to taint the investment decisions crucial to Americans’ futures. Moreover, I worry that lawyers will use this ambiguity to defend broker conduct that has no place in our markets—a result that is good for brokers and their lawyers but not for investors.

Second, I am deeply concerned about the extent to which today’s proposal actually strengthens the so-called suitability standard that has for so long failed to protect investors from conflicted brokers. As the Department of Labor’s detailed study of these questions made clear, the application of the suitability standard has too often left American families holding the bag while brokers pursue profit at investors’ expense,[6] and we should be leaving no doubt that those decisions will play no role in the application of Regulation Best Interest. I appreciate that the proposal says that “our intent [is] to make it clear that, insofar as existing broker-dealer obligations have been interpreted to stand for the principle that broker-dealers may put their own interests ahead of their retail customers . . . those interpretations would be inconsistent with Regulation Best Interest.”[7] But I urge commenters to explain how we can be even clearer that the standard in Regulation Best Interest raises the bar for the brokers who serve American investors.

Third, while requiring mitigation of broker conflicts is an important step forward, we cannot and should not rely solely on mitigation to address the most egregious practices that are pervasive in this industry. Many of the most harmful conflicts in the market today are created by the firms themselves through practices—like sales contests, quotas, and bonuses for selling proprietary products—that make little sense for investors.

I don’t think these practices have any place in a market built to serve investors instead of brokers. That’s why I believe that many of them should be banned outright. Today’s proposal makes clear that these practices “may be more appropriately avoided in their entirety for retail customers.”[8] I appreciate the important message the Commission is sending today by identifying these especially perverse incentives that ultimately harm investors—and urge commenters to help us identify the practices we need to eliminate from American markets for good.

Moreover, it’s important that these proposals contain restrictions on brokers’ ability to use the titles adviser and advisor, or to mislead investors through advertisements or communications regarding the nature of their services.[9] A robust final rule in this area should address brokers’ ability to hold themselves out as advisors in a misleading manner.

Finally, the cost-benefit analyses in these proposals do not reflect a serious attempt to evaluate the effects of our choices on real-world investors. The courts can, and should, defer to the Commission’s cost-benefit analysis so that the important work of assessing the economics of regulation is left in the hands of the experts.[10] The cost-benefit analyses in these proposals, however, are so slight that we should not expect, nor do we deserve, that deferential review. Comparing today’s proposals to the research the Department of Labor conducted has convinced me that I will be unable to support a final rule in this area unless we do more to understand how our proposal will actually affect investors.

For starters, the proposals before us ignore much of the economic literature that academics and policymakers have generated in this area for decades. To know whether the disclosures in our proposed Customer Relationship Summary will be helpful, for example, we need to know how investors will respond to these disclosures. Will investors understand the implications of what they see on Form CRS? To what degree will investors actually use that information when making the crucial decision as to who to trust with their money? There is ample literature on questions like those, and indeed our exceptional Staff has long expressed skepticism about whether and how disclosure might work in this area.[11] But little of that evidence has been seriously considered in the analysis before us today.[12]

What’s more, the Department of Labor helpfully collected that literature in what may have been the most extensive regulatory impact analysis in the history of federal rulemaking.[13] The Department then took those empirical findings and formulated predictions about the effects of rules in this area for retail investors.[14] Given that these data are available, we could have—and should have—formulated a range of assumptions that would have allowed us to meaningfully understand the costs and benefits of what we are proposing to do. Instead, the proposal before us today deals with years of research conducted by a companion federal agency in a single dismissive footnote.[15]

Perhaps the most glaring omission from our economic analyses is the absence of any attempt to assess the benefits of honest advice for ordinary investors. I counted seventeen occasions on which this proposal says that we are unable to quantify those benefits, as if our inability to calculate them precisely absolves us of our responsibility to calculate them at all.[16]

As the agency charged with protecting America’s investors, we must do more to understand the effects of this proposal on those we serve—and that work should start today. For example, we should test how investors will respond to the disclosures we’re proposing. We should conduct experiments to understand how broker-dealers will alter their recommendations in response to our rules. And we should survey market participants, from the largest institutions to the smallest retail investors, about whether and how they understand their legal rights and responsibilities. Without that work, we will have no basis to know whether we are doing the right thing for investors and for the Nation. And we will inflict the unnecessary costs of significant uncertainty if our rules face legal challenges.

* * * *

These are just a few of my concerns with today’s proposals—and I expect that commenters will identify many more. But I am mindful of the fact that, in light of recent decisions by the Administration and the courts, investors currently lack any meaningful protections from conflicted advice from brokers. And I believe that an open, public rulemaking process is the best way for us to be certain that our rules are giving investors the protections they deserve. For that reason, I am reluctantly voting to issue these proposals for comment—and look forward to continuing to work with our exceptional Staff to improve them.

This work is hard. In a world rife with a dizzying array of ever-more-complex financial products, America’s families need honest financial advice more than ever. Protecting those families from the devastating consequences of advice that serves financial professionals rather than their clients’ futures is not easy. That’s why I’m inspired by the dedication it took our Staff to bring these proposals before us—even though today is only the beginning of the conversation.[17]

This area has become the subject of such intense advocacy that it is easy to forget what really brought us all here today. Millions of Americans are approaching retirement age, and most of them don’t have the pensions that protected their parents from rising medical and housing costs.[18] Instead, they must rely on financial advice to help them plan for a secure future. For these Americans, getting the right advice can be the difference between a secure retirement and a life of constant worry.

I am grateful to the Staff for all they have done to get us to today—and look forward to the public comments that will be crucial to making sure that we get this right.


[1] See, e.g., Report of the Committee on Compensation Practices (Tully and Levitt, 1995) (describing the lengthy history in this area).

[2] See Release, United States Department of Labor, U.S. Department of Labor Extends Transition Period for Fiduciary Rule Exemptions (November 27, 2017).

[3] United States Chamber of Commerce v. Dep’t of Labor, 885 F.3d 360 (5th Cir. 2018).

[4] Id. (Stewart, Chief Judge, dissenting) (noting the Fifth Circuit majority’s unwillingness to engage with “the relevant context of time and evolving marketplace events” when evaluating the Department of Labor’s rule).

[5] 15 U.S.C. §80b-11(g) (“The Commission may promulgate rules to provide that the standard of conduct for all brokers, dealers, and investment advisers, when providing personalized investment advice about securities to retain customers . . . shall be to act in the best interest of the customer without regard to the financial or other interest of the broker” (emphasis added)).

[6] Department of Labor, Regulating Advice Markets: Definition of the Term ‘Fiduciary”: Regulatory Impact Analysis for Final Rule and Exemptions (April 2016), at 34 (“[T]he suitability standard often permits brokers to recommend investments that favor their own financial interests or the financial interests of their firm in preference to better investments that favor the customers’ interests.”).

[7] Securities and Exchange Commission, Proposing Release, Proposed Rule Establishing a Standard of Conduct for Broker-Dealers When Making a Recommendation of Any Securities Transaction, Release No. 34-____, (April 18, 2018), 68 [hereinafter Regulation Best Interest Proposing Release].

[8] Id. at 183.

[9] Particularly important is the proposal’s clear language that the prohibition on the use of particular titles is in addition to a prohibition on brokers engaging in misleading advertising. See Form CRS Relationship Summary; Amendments to Form ADV; Required Disclosures in Retail Communications and Restrictions on the use of Certain Names or Titles Proposing Release, at 183.

[10] Robert J. Jackson, Jr., Cost-Benefit Analysis and the Courts, 78 Law & Contemp. Probs. 55 (2015).

[11] See Securities and Exchange Commission, Study on Investment Advisers and Broker-Dealers (January 2011).

[12] The literature that is reviewed in our economic analysis consists of a series of decades-old (though seminal) theoretical articles about the potential conflicts that arise in agency relationships. I’m an enormous fan of Ronald Coase, but a citation to his fifty-year-old article does not reflect a reasonable review of the relevant literature on broker-dealer duties to American investors. See Regulation Best Interest Proposing Release at 219 & n.378 (citing Ronald H. Coase, The Problem of Social Cost, 3 J. L. & Econ. 1 (1960)).

[13] I am aware, of course, that the Department of Labor’s economic analysis has been the subject of criticism, including from the Commission’s former Chief Economist. See Craig M. Lewis, The Flawed Cost-Benefit Analysis Underlying the Department of Labor’s Fiduciary Rule (August 2017) (white paper written during Dr. Lewis’s tenure as Senior Advisor at Patomak Global Partners). I am disinclined to disregard years of empirical analysis of consumer behavior and financial markets—much of which was published in the top academic journals in the Nation—on the basis of a seventeen-page white paper. Whatever one’s view on that question, however, all should agree that our engagement with the Department of Labor’s analysis should extend beyond a single dismissive and unpersuasive footnote. The law, to say nothing of our commitment to American investors regarding a rulemaking of this magnitude, demands far more.

[14] See, e.g., Department of Labor, supra note 6, at 150-54 (citing, inter alia, Diane Del Guercio & Jonathan Reuter, Mutual Fund Performance and the Incentive to Generate Alpha, 69 J. Fin. 1673 (2014); Susan Christoffersen et al., What Do Consumers’ Fund Flows Maximize? Evidence from their Broker’s Incentives, 68 J. Fin. 201 (2013); Daniel Bergstresser et al., Assessing the Costs and Benefits of Brokers in the Mutual Fund Industry, 22 Rev. Fin. Stud. 4129 (2009); Matthew Morey, Should You Carry the Load? A Comprehensive of Load and Noload Mutual Fund Out-of-Sample Performance, 27 J. Bank. & Fin. 1245 (2003)).

[15] See Regulation Best Interest Proposing Release at 266 & n.460. What’s worse, as footnotes go, this one is utterly unpersuasive; the stated reason for disregarding economic analysis based upon dozens of peer-reviewed articles is that Regulation Best Interest is “different in scope” from the Department of Labor’s rule. That is, of course, a reason to make adjustments to the Department’s assumptions. It is not a reason completely to disregard that work, especially in the total absence of any other empirical estimates of the benefits of Regulation Best Interest throughout our economic analysis.

[16] See, e.g., Regulation Best Interest Proposing Release at 266 (“The Commission is unable to quantify the magnitude of the benefits that retail customers could receive as a result of the new obligations”); id. at 278 (same, as to certain costs); id. at 301 (same, as to other costs); id. at 308 (same, as to still other costs).

[17] I especially urge commenters will provide the kind of hard evidence that will allow us to conduct the serious economic analysis that will be required to justify a rule of this scale and scope. Compare Commissioner Robert J. Jackson, U.S. Securities and Exchange Commission, Statement on Proposed Amendments to Public Reporting of Fund Liquidity Information (March 14, 2018) (distinguishing “letters from industry groups” from the empirical evidence that should form the basis of our regulatory judgments).

[18] See, e.g., Alana Semuels, This is What Life Without Retirement Savings Looks Like, The Atlantic (Feb. 22, 2018).

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