Statement on Proposals Relating to Regulation Best Interest, Form CRS, Restrictions on the Use of Certain Names or Titles, and Commission Interpretation Regarding the Standard of Conduct for Investment Advisers

I would like to join Chairman Clayton in thanking the staff for their extremely hard work on these proposals. This truly was a Herculean task done in a very short period of time.

Over two hundred years ago, before any organized stock exchanges, twenty-four brokers came together under the leafy branches of a Buttonwood tree on Wall Street and established a new standard of conduct for stock trading. That agreement, known as the Buttonwood Agreement, was a mere two sentences long.[1] Those two sentences plainly set out the rules for stock trading and moderated the amount of commissions that could be charged to investors. The importance of those sentences cannot be overstated. That standard of conduct gave investors confidence, and brought stock trading out of the streets and coffeehouses and into stock exchanges, benefiting the entire American economy.

Today, we consider a package of proposals over 1,000 pages long, with more than 1,800 footnotes. Like the Buttonwood Agreement, this package also purports to establish a standard of conduct. Specifically, it purports to reform the way financial professionals interact with their retail clients, and to introduce new rules for financial professionals when they give advice. However, despite the hype, today’s proposals fail to provide comprehensive reform or adequately enhance existing rules. In fact, one might say, the Emperor has no clothes.[2]

For at least the last decade, investors have been asking for some type of fiduciary duty standard for broker-dealers who are giving advice.[3] Unfortunately, the proposals before the Commission today squander the opportunity to act in the best interest of investors. Instead, the proposals essentially maintain the status quo.

Regulation Best Interest

Let’s turn to the first of the proposed rules before us today—Regulation Best Interest. The Commission is engaging in this rulemaking because there is widespread concern that the current regulatory system for financial professionals does not adequately protect investors. Listening week after week to the Commission’s enforcement staff as they discuss their investigations into fraud, deceit, and misconduct involving financial professionals, it is clear to me that existing broker-dealer standards are not sufficient. The benchmark against which we should measure the efficacy of today’s proposed regulation is whether it will prevent this type of harm. Or, at a minimum, whether the proposal will make it easier for investors themselves—or the government—to help get their money back. I fear that this proposal may fall short of accomplishing either. Instead, it merely reaffirms that broker-dealers have to meet their suitability obligations,[4] requires some policies and procedures, and mandates a few disclosures. I said “reaffirms” because most of this is already required by FINRA or the federal securities laws.[5] With so much we could do to protect retail investors, it’s hard to fathom why we are being asked to vote on this particular proposal today.

So what does the proposed rule do? Let’s start with its name—Regulation Best Interest. This name implies that when broker-dealers give advice they will be required to put their customers’ interests ahead of their own. Unfortunately, this is not the case under today’s proposal.[6] Despite repeated requests to define what best interest means in the rule text, it was decided that there was no need to define it.[7]

Instead, this proposal allows a broker-dealer to meet its “best interest” obligation by doing three things: providing some “reasonable” disclosure about its relationship with the customer, fulfilling what are essentially the existing standards for broker-dealer conduct (i.e., suitability),[8] and having reasonably designed policies and procedures to eliminate, or mitigate and disclose the broker-dealer’s competing interests. By doing these three things, the proposed regulation protects the broker-dealer from liability or penalty, or what lawyers call a “safe harbor.” It protects the broker-dealer, not the customer.

To state it differently, does this proposal require financial professionals to put their customers’ interests first, and fully and fairly disclose any conflicting interests? No. Does this proposal require all financial professionals who make investment recommendations related to retail customers to do so as fiduciaries? No. Does this proposal require financial professionals to provide retail customers with the best available options? No.

Could we have proposed a best interest standard? Yes, we could have proposed such a standard.[9] Unfortunately, today we are not. We also could have made the provisions in the proposed safe harbor serve as a floor, instead of a ceiling. Instead, the proposal merely requires broker-dealers to meet certain minimal obligations in order to get the protections of the safe harbor and thus be in compliance with their “best interest standard.”[10]

In addition, as I mentioned previously, because there is no definition of the best interest standard in the proposal, the name of the rule, in and of itself, is confusing. Calling the proposal Regulation Best Interest could cause retail investors to reasonably believe that broker-dealers are required to act in their clients’ best interests. Perhaps it would be more accurate to call this proposal “Regulation Status Quo.” Calling it Regulation Best Interest is not just confusing, it is in effect a form of mislabeling, which may be misleading and which could have deleterious consequences.[11] Indeed, one of the recommendations we are considering today is a proposal to restrict the use of the terms “advisor” and “adviser” by a broker-dealer unless it is also registered as an investment adviser. We should be logically consistent ourselves.

So what else could we have done? Well, we could have required broker-dealers to actually eliminate or mitigate conflicts of interest, instead of requiring broker-dealers to have reasonably designed policies and procedures. We could have required broker-dealers to provide “full and fair” disclosure, instead of just “reasonable” disclosure. Moreover, we could have made a few small tweaks to the current suitability standard, so that relief could be obtained for all investors when broker-dealer misconduct is widespread.[12] In sum, we could have expected more from financial professionals who provide retail investors with investment advice. If they are going to give advice in the first place, broker-dealers should truly act in the best interest of their customers given the impact this advice can have on retail investors’ financial well-being.[13]

Furthermore, I am concerned that this rule will not only confuse retail investors, but also broker-dealers. In particular, the lack of a definition of best interest, the use of similar terms to mean different things,[14] the use of different terms to mean the same things,[15] and the possibility that the SEC and FINRA interpret the same language in their suitability standards differently.[16] All of these concerns would make it difficult for the industry to discern a clear compliance path. Any resulting confusion may well result in higher compliance costs for broker-dealers, which will likely be passed onto the investor. What’s more, the lack of a clear standard is not likely to give investors more confidence in the broker-dealer business model.

I still have many questions regarding proposed Regulation Best Interest. Indeed, I invite the public to weigh in on the many questions, which will be contained in an appendix to this statement posted online.

Relationship Summary

The remainder of today’s package, while in some respects less concerning than proposed Regulation Best Interest, nonetheless stops short of proposing meaningful change.[17] The second component of today’s package concerns how investment professionals should communicate with their clients. Throughout its history, the Commission has placed reliance on full and fair disclosure as a component of its investor protection mandate. When it’s done well, fair and objective disclosure is fundamental to sound decision-making. Relevant and reliable information allows the public to make informed decisions about what to purchase—whether it’s a type of car, a type of milk, a type of stock, or in the case at hand, the type of financial professional to hire. Simply put, good disclosure empowers a person to decide for him or herself the appropriate course of action. However, disclosure must have the appropriate form and content. And it must be presented at the appropriate time for it to be meaningful and effective. Today’s proposal is disappointing in this regard.

Today’s proposal is intended to help cure investor confusion. More specifically, it is designed to help retail investors understand the difference between hiring an investment adviser versus hiring a broker-dealer. To this end, the proposal would require an investment adviser or a broker-dealer to provide a brief relationship summary to retail investors to inform them about the relationships and services it offers. The summary would also describe the standard of conduct under which the adviser or broker-dealer operates, its fees, specified conflicts of interest, and whether it has reportable legal or disciplinary events.[18] To be sure, these are areas where disclosure might help cure investor confusion. The question I have, though, is whether we are proposing disclosure that is both too generic and too legalistic such that retail investors won’t bother to read it. We are all too familiar with the stilted boiler-plate jargon that riddles today’s corporate disclosure documents. And we, at the Commission, understand far more about what makes disclosure effective than is evident in today’s proposed rules. Take the following passage from the mock relationship summary:

We must act in your best interest and not place our interests ahead of yours when we recommend an investment or an investment strategy involving securities. When we provide any service to you, we must treat you fairly and comply with a number of specific obligations. Unless we agree otherwise, we are not required to monitor your portfolio or investments on an ongoing basis.[19]

These three sentences are intended to describe a broker-dealer’s obligation to its retail clients. But what I am asking is whether this passage would be effective in curing retail investor confusion regarding the obligation it is describing. As an initial matter, the disclosure is confusing. What does best interest mean? We may never know because Regulation Best Interest, as I described earlier, does not define what best interest means.[20] Furthermore, would this disclosure stand up to the test of a high-pressure sales situation, where the investment professional uses every tactic in the book to entice the investor to sign on the dotted line? If, as commenters have suggested in the Commission’s Study on Investment Advisers and Broker-Dealers, “retail investors…find the standards of care confusing…,”[21] a simplified recitation of a broker-dealer’s obligation goes only part of the way.

We should be proposing disclosure that goes a step further. The disclosure should provide a retail investor with a meaningful understanding of the application of the obligations to the investor. In other words: What does best interest mean to me, in my particular situation? Or, with respect to fees, how much would I pay per year for an advisory account? How much for a typical brokerage account? What would my return be without netting fees? What would make those fees less or more? Without these types of disclosures, we will likely run the risk that a retail investor simply glances at these words and shoves them in the back of the file cabinet, or worse, the recycling bin, along with the rest of the boilerplate disclosure he or she receives.

In fact, today’s proposal in some ways recognizes the inadequacy of the proposed disclosure. At the end—not the beginning—of the relationship summary is a list of “Key Questions to Ask.”[22] The release states that these questions are “intend[ed] to encourage retail investors to have conversations with their financial professionals about how the firm’s services, fees, conflicts and disciplinary events affect them.”[23]

Let’s think about this for a moment. We are asking a retail investor to flip through four pages of boilerplate text, read through a series of questions, and then take the initiative to engage in a conversation with his or her financial professional about matters with which he or she may not be familiar. Why are we, in effect, placing the onus on a retail investor to cure his or her own confusion? Shouldn’t we be helping financial professionals develop disclosure that would help cure such confusion? What’s more, the efficacy of this approach is wholly dictated by the veracity of the financial professional’s oral responses. And when you combine this with the proposal’s delivery and extremely generous updating requirements,[24] I wonder if what is being proposed will actually spawn more confusion. I fear that this proposed disclosure will not only fail to add incremental value, but may also draw attention away from specific, decision-useful information.

Perhaps we could expect retail investors to flip through and take seriously four pages of boilerplate language if its presentation was visually dynamic and engaging. But, here too, the proposal falls short. And we, at the Commission, don’t have any excuse, to boot. We have learned over the years—most recently at the October 2017 Investor Advisory Committee meeting[25] and the March 2017 POSITIER Evidence Summit[26]— that using certain visual, design-oriented techniques could get more investors to pay attention to the “fine print.”[27] Some examples include:

• providing disclosure in the form of tables, bullet point lists, check lists, and other formats that provide greater structure and comprehensibility;
• using more white space, avoiding the temptation to overcrowd the communication;
• color-coding information to illustrate parts of the disclosure more effectively; or
• illustrating the disclosure content with visuals like icons, charts, pictograms, and other media that take it out of abstract text and ground it through imagery.[28]

What does today’s proposal do on this front? It states that “firms would be permitted to use charts, graphs, tables, and other graphics or text features to explain the information, so long as the information is responsive to[,] and meets the requirements in[,] the Instructions (including the space limitations).”[29] Not especially encouraging in its use of new techniques.

I recognize that we and our staff at the Commission are not necessarily graphic artists, but we would be foolish not to at least try and capitalize on what we’ve learned from those who are. We could propose that the relationship summary explicitly require these elements and request comment on specific forms that may work. In fact, I invite the public to review an example—which will be posted in another appendix to this statement online—of some forms of presentation today’s proposal could have utilized. I also recognize that there may be cost or administrative challenges for firms to provide more personalized disclosure. But, again, this is a proposal. If we are trying in earnest to help retail investors understand what they are getting into, we should at the very least try to sufficiently advance the ball.

Restrictions on the Use of Certain Names or Titles

The third element of today’s package is a proposal to restrict a broker-dealer from using the words “adviser” or “advisor” in its name or title when communicating with a retail investor, unless the broker-dealer is a registered investment adviser. This proposal, like the relationship summary, moves in the right direction. But more can, and should be done. After all, restricting the use of only two words presents an obvious “whack-a-mole” problem.

It seems to me that a broader, more principles-based approach would prove far more effective. For example, we could preclude a broker-dealer from “holding itself out” as an investment adviser to the extent it is not an investment adviser or acting in an advisory capacity. Perhaps this could take the form contained in the money market funds rule?[30] Or it could be premised on the antifraud concept of a materially misleading statement? I welcome comment on what might be the most effective approach to achieve this end, taking into account the Commission’s authority and any other legal concerns. In particular, I hope that the public provides strong empirical data that quantifies the harm to investors, individually and in the aggregate, that would occur if the Commission does not adopt a “holding out” approach.[31]

Proposed Commission Interpretation on Investment Adviser’s Fiduciary Duty

The final component of today’s package is a proposed Commission interpretation of the fiduciary duty owed by an investment adviser.[32] Importantly, the proposed interpretation is limited to certain aspects of an adviser’s fiduciary duty under section 206 of the Advisers Act.[33] And, even then, it is not intended to be an exhaustive resource.[34] I understand that an adviser’s fiduciary obligations are seen by some as ambiguous. I think clarification of the law is always a good thing. I am just a little confused as to why the Commission might be in the best position to issue interpretive guidance on an area that is heavily informed by decades of common law. I am also worried that, by limiting the interpretation to those duties under section 206, we may be, indirectly, suggesting a narrowing of an adviser’s broader fiduciary duties.

Conclusion

Unfortunately, the problem we are attempting to address is an insidious one. We must remember that today’s proposals will have real effects on real people.[35] After all, most investors will not realize that they should have been earning a higher return or haven’t been presented with the best investment options.[36] Our decision regarding the standard to which a financial professional must be held may affect someone’s ability to buy a new home, send a child to college, or retire. The impact of the proposed rules is especially important in today’s era, with most employers no longer providing pension plans.[37] This makes it all the more important that we give retail investors a fighting chance. Their future depends upon us getting this right. When the question is whether to defer to financial professionals’ historical practices that have caused known harm, or to give investors better disclosure and better advice, we should err on the side of the retail investor. It is the financial professionals who have the information and the ability to fix the problem—not their customers. Thus, when there is a question of where the burden of uncertainty should rest—it should rest with the more informed party—the financial professional. Unfortunately, today’s package of proposals in many ways continues to place the burden on the retail investor. What’s more, I believe the proposals, in their recommended forms, would make it difficult for the Commission to adopt materially improved rules going forward. As a result, I find myself unable to support today’s package of proposals.

Commissioner Stein’s Requests for Comment

General

1. Should the Commission’s proposal require financial professionals to provide their retail customers with unconflicted investment advice?
2. Should the Commission’s proposal require all financial professionals to put the interests of retail customers first, before their own interests? Why or why not?
3. Should the Commission’s proposal allow different standards for different groups that give investment advice to retail investors? For example, should the Commission require investment advisers to be impartial and disinterested on an ongoing basis, but subject other investment intermediaries (such as broker-dealers) to episodic standard of conduct? Why or why not?

“Best Interest”

4. Should the Commission’s proposal define what “best interest” means? Should the Commission adopt the following definition:

   “To act in the best interest” means when a broker, dealer, or natural person who is an associated person of a broker or dealer, makes a recommendation, the recommendation reflects the care, skill, prudence, and diligence that a prudent person acting in a like capacity and familiar with such matters would use taking into consideration all of the facts and circumstances, including the investment profile of the Retail Customer to whom the recommendation is made?

   If the Commission does not define “best interest,” will broker-dealers and their customers understand their obligation?

5. How does a broker-dealer’s obligations to retail customers change under the Commission’s proposal? The current suitability standard requires broker-dealers to give recommendations that are in the best interest of their clients. How is the proposal different than the current standard?
6. What is the difference between the following three standards of conduct that would be applicable to broker-dealers:
   • Proposed Regulation “Best Interest” for retail customers;
   • FINRA’s suitability standards for other non-institutional customers; and
   • FINRA’s institutional suitability obligations for institutional customers?
7. Should dually registered advisers (broker-dealers and investment advisers) be required to tell their retail customers, in writing, when they switch between roles? For example, should retail customers be told when a registered financial adviser with a fiduciary duty switches to a financial advisor with no fiduciary duty (e.g., proposed Regulation Best Interest)? Should retail customers receive notice of the implications of this change?
8. Should broker-dealers who agree to monitor their clients’ accounts be subject to the proposed best interest standard? Or should they be required to register as investment advisers or held to a fiduciary standard?
9. Should broker-dealers who have discretionary authority over their customers’ accounts be required to register as investment advisers or held to a fiduciary standard?
10. Should the Commission’s proposed best interest standard apply only to “securities transactions” or to “transactions involving securities”?

Material Conflicts

11. Should the Commission’s proposal require broker-dealers to eliminate or mitigate and disclose all material conflicts of interest? Why or why not?
12. The Commission’s proposal does not prohibit any material conflicts. Should the Commission’s proposal prohibit certain material conflicts of interest? Why or why not?
13. Should individual broker-dealers, as well as broker-dealer entities, be required to mitigate and disclose their conflicts of interest?
14. How is the proposed requirement for a broker-dealer to “reasonably disclose” material facts related to the scope and term of the relationship different from existing obligations under the federal securities laws, state law, and self-regulatory organization rules? Should we require broker-dealers—who possess greater information than their retail customers—to fully and fairly disclose the scope and terms of the relationship?
15. Should the “reasonableness” of a recommendation depend only upon the suite of products offered by the broker-dealer? For example, should a broker-dealer consider other products in the marketplace, such as those that are offered by other firms?

Public Interest and Investor Protection

16. Should the Commission promulgate this rule under the anti-fraud provisions of the Exchange Act?
17. Is this rule, given the safe harbor it contains, enforceable by the Commission? What proof would be necessary to bring an action? How does the safe harbor relate to the intended purpose of the rule, to ensure that broker-dealers make recommendations that are in their customers’ best interest? Would there be unintended consequences?
18. How would the proposal advance the Commission’s ability to obtain recompense for all the victims of widespread breaches of the suitability requirement? Would the Commission need to prove the unsuitability of the recommendation for each, of possibly thousands, of harmed customers? For instance, should the Commission have required broker-dealers to reasonably believe that the recommendation is appropriate for the category of investor to which the retail customer belongs?
19. Should the proposed “best interest” standard be confined to the safe harbor contained in the rule, or should it be a larger, more encompassing obligation?
20. Should a broker-dealer’s obligation be limited to the moment in time in which the recommendation is made? Are there circumstances in which that recommendation should be updated if it has not yet been acted on?