Back to General Resources

House Financial Services Subcommittee Hearing on Reg BI

House Financial Services Subcommittee on Investor Protection, Entrepreneurship and Capital Markets

“Putting Investors First? Examining the SEC’s Best Interest Rule”

Thursday, March 14, 2019

Key Topics & Takeaways

  • Preserving Choice and Access: Asked how Reg BI would help preserve investor access and choice, Pitt explained that the proposed rule would in fact preserve choice and access while maintaining a high level of professionalism in the industry. Pitt said that without financial advice from professionals, investors wind up losing money “in virtually all cases,” saying that the goal is to ensure investors have access to advice and that it puts their interest first.
  • Best Interest Obligation: Rep. Ann Wagner (R-Mo.) asked a series of questions confirming details of Reg BI. Pitt confirmed that Reg BI imposes an obligation on broker dealers to make recommendations in the best interest of their client, expressly forbids a broker dealer from putting their own interests ahead of their client, lays out affirmative duties of disclosure, a standard of care, and to mitigate or eliminate conflicts, clarifies titles, and defines a best interest standard.
  • Investor Testing: Casten, who’s draft bill the SEC Disclosure Effectiveness Testing Act would require the SEC to conduct usability testing on new disclosure forms, expressed concern that the SEC over-relied on surveys rather than in-depth interviews regarding proposed Form CRS. Roper said that investor testing is “absolutely” effective, saying if the SEC were required to conduct “real” usability testing of their disclosures, they would get real information about how to improve them, adding that the SEC should “absolutely” republish and retest the disclosure prior to finalizing the rule.

Witnesses

Opening Statements

Rep. Carolyn Maloney (D-N.Y.), Chairwoman, House Financial Services Subcommittee on Investor Protection, Entrepreneurship and Capital Markets

In her opening statement, Maloney discussed the history of congressional and regulatory action in this space, beginning with the Dodd Frank Act, the Department of Labor (DOL) fiduciary rule, and culminating with the Securities and Exchange Commission’s (SEC) proposed Regulation Best Interest (Reg BI). Maloney noted that Dodd Frank required the SEC to conduct a study on the appropriateness of a fiduciary standard for broker dealers, authorizing the SEC to write a rule if it found one necessary. Maloney said that while Reg BI may be an improvement over the existing standard, it is still “far too weak” and she still has “serious” concerns. She explained that Reg BI does not create a uniform fiduciary duty as the DOL’s rule would have, does not define “best interest,” and allows broker dealers to take financial incentives into account when making a recommendation, leaving retail investors “exposed to substantial losses” due to conflicted advice. Maloney noted proposed legislation from Rep. Sean Casten (D-Ill.), the SEC Disclosure Effectiveness Testing Act, which would require the SEC to conduct usability testing on new disclosure forms. Maloney called it an “excellent idea” and urged the SEC to strengthen the proposed rule.

Rep. Bill Huizenga (R-Mich.) Ranking Member, House Financial Services Subcommittee on Investor Protection, Entrepreneurship and Capital Markets

In his opening statement, Huizenga said that millions of Americans are working to achieve their financial goals and save for retirement, which takes careful financial planning that can benefit from the help of an investment advisor or broker dealer. He said that sound financial advice is critical, and therefore so is ensuring access to affordable and reliable advice. Huizenga said the DOL fiduciary rule denied access to small savers and limited the products available to them, but since the rule was vacated by the courts, the SEC has proposed a “significant” rulemaking package designed to better serve retail investors. Huizenga noted that SEC Chairman Jay Clayton said the package was designed to serve main street investors by requiring broker dealers to act in the best interest of their clients, reaffirm and clarify the duty they are owed, and state clearly the facts of their relationship, including financial incentives. Huizenga said Reg BI is putting investors first, and although there are refinements necessary, it “significantly” raises the standard of care and consumers will be able to make more informed decisions.

Rep. Patrick McHenry (R-N.C.)

In his opening statement, McHenry called Reg BI a “simple concept that addresses a very complex problem,” adding that regulation must protect investors and give them the tools they need to make good decisions while preserving their access and choice. He said Reg BI ensures customers will not only have unfettered access and choice, but will also have a heightened standard of care, setting investors’ best interest as the overarching standard of conduct.

Testimony

Susan MacMichael John, Chair, Certified Financial Planner Board of Standards, Inc.

In her testimony, John explained the Certified Financial Planner Board of Standards (CFP Board) first adopted a fiduciary standard in 2007, requiring certified financial planners (CFPs) to act as a fiduciary when providing financial planning. She said that last year, the CFP Board adopted a revised code, extending the application of fiduciary duty from financial planning services to all financial advice. John expressed concern that Reg BI offers the “appearance” but not the reality of increased investor protection, though if strengthened it could realize this goal. She said the most “significant” areas for improvement include clearly defining “best interest” and including a “distinct, standalone” duty of loyalty. John also expressed support for the SEC Disclosure Effectiveness Testing Act, saying disclosure should not be a substitute for “clear and effective” regulation.

Dina Isola, Investment Advisor Representative, Ritholtz Wealth Management

In her testimony, Isola discussed various incentive programs utilized by broker dealers, criticizing activities that tie recommendations to incentives and compensation. Isola said a “web of toxic incentives” can result in bad advice that harms investors, and a lack of fiduciary protections leaves investors paying “excessive fees” for “poor outcomes.”

Barbara Roper, Director of Investor Protection, Consumer Federation of America

In her testimony, Roper said Reg BI provides “few meaningful protections” and “weakens” existing investor protections. Roper said that Reg BI does not require broker dealers to recommend the investments that are best for their customers, and that “best interest” is not defined in the rule text, adding that the rule is “essentially unenforceable.” Roper explained that the requirement to mitigate conflicts of interest “has potential,” but said there is no indication of how the SEC would measure this, and Roper critiqued the proposed rule for not banning incentives that encourage advice not in the best interest of clients. Roper said basic changes are needed to raise the bar on existing FINRA suitability standards, adding her strong support for the SEC Disclosure Effectiveness Testing Act.

Lee Baker, President, AARP Georgia State

In his testimony, Baker said the AARP has long advocated for policies that strengthen Americans’ ability to save and plan for retirement, applauding the work of the SEC to improve the standard of conduct. Baker said, however, that Reg BI does not impose an explicit fiduciary standard or define “best interest,” recommending the adoption of the state trust definition of “best interest,” in which a financial professional would have to make recommendations both “solely in the interest” of the consumer and with the “care, skill, prudence, and diligence that a prudent person acting in a like capacity and familiar with such matters would use.” Baker added that Form CRS should be simplified to empower consumers to make decisions, and that disclosure is not enough and does not provide adequate protection or shield investors from harm.

The Honorable Harvey L. Pitt, Chief Executive Officer, Kalorama Partners

In his testimony, Pitt said Reg BI improves upon existing law, adding the SEC has put out a “thoughtful and creative proposal” designed to improve protections. He said Reg BI should be seen as an initial step, not a final one, and that unlike other rules the SEC has adopted, experience will be the “best determinant.” Pitt pointed out that the SEC has sought investors’ views and is continuing to refine the rule, working through 6,000 comment letters that will help produce a final rule that will “get the process started” in the right format. Pitt said that most criticisms of the rule reflect a misunderstanding of the actual terms of the proposal and the efforts that went into its creation. He also noted that the SEC Disclosure Effectiveness Testing Act, while having “real value in some circumstances,” is an “ill-advised” piece of legislation in its current form that would prevent the SEC from implementing the needed reforms that Reg BI serves.

Question & Answer

Best Interest Obligation

Asked by Maloney what the most important changes that can be made to Reg BI are, Roper responded that the SEC should start by “making the best interest standard meaningful” and narrow it beyond what currently satisfies FINRA suitability standards. Isola noted that many investors do not know if their financial professional is required to give advice in their best interest, adding that any lack of clarity “leaves the door wide open for abuses.” John said the SEC should define “best interest” and include a duty of loyalty.

Huizenga noted that much of the criticism of Reg BI says it is a weaker standard because it is different from the DOL fiduciary rule. Pitt explained that the SEC standard is superior because it draws on the DOL’s experience but covers all retail investor accounts, rather than the narrow jurisdiction of the DOL to cover only a portion of retirement accounts. Pitt added that it is “crucial” to ensure low- and middle-income savers have the necessary protections and their securities professionals understand their obligation to act in the best interest of their clients.

Rep. Ann Wagner (R-Mo.) asked a series of questions confirming details of Reg BI. Pitt confirmed that Reg BI imposes an obligation on broker dealers to make recommendations in the best interest of their client, expressly forbids a broker dealer from putting their own interests ahead of their client, lays out affirmative duties of disclosure, a standard of care, and to mitigate or eliminate conflicts, clarifies titles, and defines a best interest standard.

Existing Suitability Standard

Asked by Rep. Andy Barr (R-Ky.) if there are existing rules such as the FINRA suitability standard that cover many of the provisions in Reg BI, to which Pitt replied there are not, including the requirement to disclose and eliminate conflicts, upfront disclosure about the nature of the relationship, and written disclosure of material conflicts, saying Reg BI improves upon the status quo.

Rep. Brad Sherman (D-Calif.) applauded the SEC for taking action and asked witnesses whether they agreed that Reg BI would be better than no action at all. Roper, Isola, and John argued that no rule at all would be better, with Roper positing that the rule “deprives investors of protections” and John adding that it “undercuts what existed before.” Baker said that he does not want the perfect to be the enemy of the good, and Pitt said finalizing the rule would be an “enormous” improvement over the status quo.

Preserving Choice and Access

Reps. Warren Davidson (R-Ohio), Trey Hollingsworth (R-Ind.), and Steve Stivers (R-Ohio) asked how Reg BI would help preserve investor access and choice. Pitt explained that the proposed rule would in fact preserve choice and access while maintaining a high level of professionalism in the industry. Pitt said that without financial advice from professionals, investors wind up losing money “in virtually all cases,” saying that the goal is to ensure investors have access to advice and that it puts their interest first.

Huizenga said that it is widely accepted knowledge that brokers can offer lower account minimums than fee-based accounts, expressing concern that there are not many fee-based advisors that would step in to serve those smaller accounts. Pitt said that it is crucial to ensure that lower- and middle- income investors have protections in place while permitting those investors to access a wide range of services.

Disclosures

Reps. French Hill (R-Ark.) and Davidson asked about the effectiveness of disclosures. Pitt said that under Reg BI, it would be required for investors to receive information that would “precisely and surgically” highlight conflicts of interest and enable them to question their financial professionals and make judgements based on that information. Isola said the average investor does not understand much, and often do not read or understand disclosures. John added there should be further testing of Form CRS.

Conflicts of Interest

Rep. Katie Porter (D-Calif.) asked a myriad of questions about incentive structures for broker dealers and whether Reg BI outright prohibits these. Pitt responded that while he agrees that certain incentives may influence bad behavior, under the SEC proposed rule such incentives would be prohibited if, depending on each individual circumstance, it does not put the client’s best interest first. Asked by Stivers how broker dealers would handle conflicts under the rule, Pitt explained that they would be required to identify material conflicts. He continued that when a conflict cannot be remediated, the transaction cannot go forward, calling it a “flexible” approach that will provide the greatest amount of protection. Roper added that reigning in conflicts does not necessarily mean eliminating all of them, but instead focusing on the most egregious that incentivize not acting in the best interest of clients.

Investor Testing

Casten expressed concern that the SEC over-relied on surveys rather than in-depth interviews regarding proposed Form CRS. Roper said that investor testing is “absolutely” effective, saying if the SEC were required to conduct “real” usability testing of their disclosures, they would get real information about how to improve them, adding that the SEC should “absolutely” republish and retest the disclosure prior to finalizing the rule. Baker added that divergent results that consumers like Form CRS but do not understand it shows there is work to be done, saying the simpler the document is, the better.

Asked by Barr if the SEC could get stuck in an “infinite loop” of investor testing under the SEC Disclosure Effectiveness Testing Act and if it could prevent finalizing Reg BI and harm investors, and Pitt replied it could.

For more information on this hearing, please click here.