The Fiduciary Rule, “Regulation Best Interests”, and Suitability Standards: Trump’s Rollback of Obama Investor Protections

It should come as no surprise that since he entered office Pres. Trump has undone the investor protection regulations that President Obama instituted in 2015. Five years ago under orders from Pres. Obama, the Department of Labor proposed regulations that would have implemented the “Fiduciary Rule”. This rule would have expanded the fiduciary obligations that already apply to investment advisors by also making them apply to brokers and insurers who sell investment instruments (e.g., stocks, bonds, annuities, life insurance, etc.) or provide related advice. Such fiduciary requirements mandate that investment professionals provide their clients with duties of loyalty and care, among other protections, thereby putting the client investors’ interests and needs above their own financial and other interests. This Fiduciary Rule was set to replace the prior “suitability” standard that applied to such investment professionals who, in selling investment instruments or providing advice to clients, were required to solely consider the suitability of such to the investor’s portfolio goals.

The Obama Fiduciary Rule was fast-tracked and thus released in its final version a year later in April 2016. Financial industry pressure prevailed, and the final version was temporarily delayed prior to activation. One delay led to another, so much so that once Pres. Trump entered office in January 2017 the Fiduciary Rule was still not activated. Immediately, Pres. Trump issued orders to delay it even further. A year later, industry-backed plaintiffs found success in their legal challenges to the Fiduciary Rule, arguing that the rule was an unreasonable burden and arbitrary and capricious. See Chamber of Commerce et al. vs. Department of Labor et al. (Fifth Circuit Court of Appeals, March 2018).

A month after the Fifth Circuit Court’s decision, the Securities and Exchange Commission (“SEC”) proposed a watered down version of the Fiduciary Rule, namely Regulation Best Interests (“RBI”) — a clunky name whose acronym seems to hearken us to the metaphorical homerun hit by the Trump Administration on behalf of Team Billionaire. This new regulation was finalized by the SEC in 2019, and it becomes effective on June 30, 2020. While largely maintaining the fiduciary requirements on investment advisors, it does not apply those same requirements to other investment professionals, be they broker-dealers or insurers who sell investment instruments or provide advice. RBI prohibits broker-dealers from calling themselves advisors unless they are dual registered as such, nominally requires them to put some interests of their clients first when selling them investment instruments, requires them to disclose conflicts of interest and fee structures to clients, and sometimes might require them to try to mitigate or eliminate conflicts of interest.

Certainly this is a more protective infrastructure for investment clients than the prior “suitability standard” protocol. Despite ham-fisted arguments to the contrary by the Trump administration’s questionable consecutive SEC Chair appointees (e.g., see this or this), the RBI protocol is a far cry from the legal and financial protections afforded to individual investors by the Fiduciary Rule, nevermind the more aggressive statutory and legal penalty structure of the latter. Clearly that’s intentional, as the Trump administration has made it a high priority to reduce governmental regulations and assist wealthy corporations. That the SEC even bothered to put forth any measure of protections for investors is a testament to the power of political opinion, for how else could Pres. Trump do so much for Team Billionaire while being able to convince his base that he cares so deeply about Team Everybody Else?

While wealthy and experienced individual and institutional investors do not need to rely on a stockbroker’s disclosures of conflict of interest or need to be warned about the disadvantages of certain investment instruments in comparison to others, as such seasoned investors have their own well-paid advisors, attorneys, and strategists, it is of course inexperienced mom-and-pop investors, young investors, and small business owners managing investment portfolios for themselves and their employees who need the protections that the Fiduciary Rule sought to give them.

Now individual investors are far more exposed under the current “Regulation Best Interests” standard. The language of broker disclosures can be confusing for such investors, though that is the most substantial protection offered by the RBI. Pared down, such disclosures go something like this: “We will recommend stocks and funds for you to buy based on what we believe is in your best interests. Having said that, we have various financial and legal interests that may or actually do conflict with your best interests, and these conflicts are disclosed here as A, B, and C. We have tried to mitigate these conflicts by doing X, Y, and Z. For each investment you buy we make money up front and potentially even more down the road whether you make money or not on that investment. You better do your own homework regarding your investment portfolio because we’re not doing it for you unless you pay us even more. We provide you no portfolio advice unless you pay us to do so. Our duties and liabilities to you are limited by the RBI and other regulations of the SEC.”

If you have little experience as an investor working with a broker or dealer, you may not realize what a problematic relationship that really might become. The differences become stark when you compare it to what services and protections fiduciaries such as registered investment advisors provide. While fiduciaries are required to watch out for their client’s interests over the entire course of their professional relationship, investment brokers and dealers under the RBI standard are not, unless their clients pay them an extra fee for doing so. Fiduciaries are required to ensure that there are no actual conflicts of interest prior to accepting a new client and are required to disclose any potential conflicts of interest to a client and acquire informed written consent to continue the professional relationship in light of such potential conflicts. Conversely an investment broker or dealer under the RBI standard arguably checks the box by simply making a written disclosure of a conflict of interest and then nevertheless employing a “duty of care” to act in the client’s best interests despite that conflict. This is exactly the kind of ominous high-wire act that a fiduciary must avoid, as it too often ends in damage to the client.

For example, under the RBI rules, a broker can arguably make money by selling an investor stocks from its own portfolio or from the portfolios of its third-party partners or sponsors. It can potentially encourage its client investors to buy such stocks based in part on that self-serving incentive so long as the broker can argue that it’s also in the investors’ best interests to do so. The broker can arguably recommend to its clients certain funds over others when the broker can make more money on such purchases, and it can potentially recommend clients to work with certain portfolio managers over others when that manager will better compensate the broker. As more and more lawsuits against such investment broker/ dealer actions and against the SEC’s “Regulation Best Interests” rules themselves make their way through the court system, we will see what judges think of the inherent conflicts of interest that the RBI infrastructure creates and abides.

In the meantime, what happens if an investment dealer or broker drops the ball and damages the client’s interests: Nothing, so long as he checked the boxes! And given the parameters of the RBI structure, that’s not that hard to do as it’s often settled by routine business practices and good disclosure statements similar to the Terms of Use we automatically agree to when we download apps onto our smartphones. Under laws pertaining to fiduciaries such as investment advisers, however, the penalties for financially injuring a client can be steep, including punitive damages for breach of fiduciary duty; and the triggers for such penalties are far more sensitive. Again, this failure by the Trump administration to protect small investors while helping large financial corporations is no accident.

Caveat emptor! Buyer beware, people, like nobody’s business! And vote for political candidates up and down the ballot who will reverse course and bring back the regulatory protections that stop the race to the bottom that deregulation causes.

Exclusive Legal Representation for Discerning Clients. Serving CA, NY, WA, MA, DC. Business, Criminal, Divorce, & Education Law. www.AliEsq.com

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