June 14, 2018

Securities and Exchange Commission “Investor Advisory Committee Meeting”

Key Topics & Takeaways

• Best Interest Standard: Panelists discussed the merits and various suggested changes to the Securities and Exchange Commission’s (SEC’s) proposed Regulation Best Interest, including that the proposal preserves investor access and choice, enhances the existing regulatory regime, and protects investors, though may need changes to improve clarity and consistency.
• Form CRS: Panelists also addressed proposed Form Client Relationship Summary (CRS) and debated whether the form provided sufficient disclosures in a way that would be understood and utilized by investors. Panelists agreed that disclosures must use simple language that investors can understand and provide the most vital information upfront to be most helpful for investors to make informed decisions.

Opening Statements

In her opening statements, SEC Commissioner Kara Stein explained features of proposed Regulation Best Interest, including minimum standards of conduct for broker-dealers when acting for retail investors and the proposed CRS disclosure document. Stein noted than many have been focusing on this issue for years, and it is one of the mostly closely-watched aspects of investor protection. Stein questioned how the standard could help alleviate investor confusion, whether Form CRS would properly inform prospective clients about their relationship with their investment professional, and if it will help investors make more informed decisions.

Commissioner Robert Jackson said that there are a number of important matters to discuss regarding the newly proposed rules, most importantly the “critical” investor testing being done by the Investor Advocate Office on how these new measures, and particularly Form CRS, will be received by the public, noting that before moving forward it is essential to understand how investors will respond.

Panel 1: Discussion of the Commission’s Proposed Regulation Best Interest and Proposed Restriction on the Use of Certain Names or Titles

Maureen Thompson, Vice President for Public Policy, CFP Board of Standards

Thompson discussed the work of the CFP Board, including granting certification to CFP professionals and upholding a standard of competence and ethics for financial professionals. She stated the CFP Board supports a fiduciary standard, noting the CFP Board recently updated their own standards to reflect this. Thompson expressed concern that as it is introduced, the proposed Regulation Best Interest may offer the “appearance” but not the “reality” of increased investor protection, but with revisions and appropriate implementation, the SEC can realize its goal of protected investment advice. Thompson said that the proposed regulation distinguishes between different kinds of conflicts and treats them differently, unlike other standards with uniform methods of addressing conflicts. Thompson said she hopes the proposal will be strengthened as it moves forward, and that the SEC makes publicly available the results of their investor testing, so the public can fully evaluate the effectiveness of the rule proposal.

Micah Hauptman, Financial Services Counsel, Consumer Federation of America

Hauptman said that the current proposal relies too heavily on disclosures, with “gaps in applicability.” Hauptman said that SEC “can and should” adopt clear best interest standards, but the proposal “lacks clarity” and could leave unsophisticated investors at risk. Hauptman noted that the proposal applies on a transaction basis, but does not require an ongoing duty to customers, which could result in “mismatched expectations” from clients. Hauptman stated that the SEC should adopt a fiduciary standard from both broker-dealers and investment advisers and expand the applicability of the best interest standard so there are no gaps to leave investors unprotected. He continued that the SEC should work to better ensure conflicts of interest are not allowed to “taint” recommendations, including quotas and other artificial incentives.

James Allen, Head, Capital Markets Policy for the Americas, CFA Institute

Allen called for “clarity and consistency” in the proposal, and a consistent application of fiduciary duty standards for those that supply investment advice. Allen additionally called for “clear and regular” disclosure of broker-dealer duties of loyalty to customers, noting that proposed Form CRS “takes important steps in the right direction” to provide clarity. Allen said that the regulation may be adding to an “already muddled” regulatory regime and declines to define the meaning of “best interest.” Allen said that investors need time to understand what is included in Form CRS in order to also understand the Regulation Best Interest disclosures.

Karen Barr, President & Chief Executive Officer, Investment Adviser Association

Barr said a best interest standard is a “bedrock principle” and a “complex and critically important initiative” of investor protection, and that the principles underlying the fiduciary duty should apply to all financial professionals providing advice about securities. Barr said the proposal would protect millions of investors and enhance investor understanding and strengthen the existing standard of conduct. Barr expressed concern regarding certain aspects of the requirements under the proposal, including the potential for investor confusion, vague requirements for some disclosures, and that the standard would only apply at the time of and to a specific recommendation, rather than the entire relationship between an investment professional and their client. Barr also called for the results of the SEC’s investor testing to be made public, and for the comment deadline to be extended so those results can be incorporated into comments.

Ira Hammerman, Executive Vice President and General Counsel, SIFMA

Hammerman stated that SIFMA has long supported the creation of a heightened best interest standard for broker-dealers that builds on the existing regulatory regime and supports consistent, high standards, including putting a client’s best interest first. Hammerman noted that although the SEC’s proposal does not explicitly use the term “fiduciary,” that does not mean the SEC is proposing any less of a stringent standard and does include both a duty of loyalty and duty of care. Hammerman said the proposal seeks to maintain distinction between broker-dealers and investment advisers, and ensures both are held to a high standard, which “clearly and significantly raises the bar” and incorporates the intended principles and goals of the former Department of Labor (DOL) fiduciary rule, adding further protections while preserving access and choice for investors. Hammerman noted that because the proposal includes a duty of care, skill, and prudence, it will hold financial professionals accountable for failures of knowledge or skill, continuing that the proposal would apply to all retail customer accounts, not solely retirement accounts, with the addition of SEC enforcement capability. Hammerman pointed out that the proposal intended to be principles-based, and that “best interest” was never intended to be a defined term, but rather an obligation that is satisfied by meeting care and conflict of interest obligations.

Discussion

In discussion with the panelists, Investor Advisory Committee (IAC) members inquired about a number of issues. Barbara Roper inquired whether panelists would be comfortable with calling the proposal a fiduciary standard, receiving clear guidance that best interest means recommending the best of the reasonably available investments, and with a definition of mitigation of conflicts that states firms cannot artificially create incentives. Thompson and Hauptman replied that it should be a fiduciary standard, and that firms should not artificially create incentives. Hammerman and Thompson said that there should be clear guidance on what “best interest” means. Barr and Allen agreed that a fiduciary standard applies to an entire relationship, so while it would not apply in this case, the proposal does draw on fiduciary principles.

J.W. Verret asked what “duty” and “care” mean in this context, and how enforcement would play a role in addressing concerns. Allen replied that there is very little context around what a “fiduciary duty” means, and so it has to be broken down to elemental parts: loyalty, prudence, and care. Hauptman replied that a duty of prudence means to act as a prudent professional, taking a menu of all alternatives available and making a recommendation without considering financial incentives. Hauptman mentioned that compensation between comparable products, such as mutual funds, should be levelized in order to remove incentives, and enhanced surveillance should be enacted to ensure recommendations best serve clients.

Damon Silvers asked the panel to discuss whether the SEC needed more research into what investors understand about their relationship with their financial professional. Thompson responded that the CFP Board has conducted focus groups to examine how customers decide who to work with, what they know, and what they expect. Thompson continued that most respondents are “unsophisticated” and work with someone who has been recommended to them, and most do not know what type of financial professional they are working with. Thompson said the obligation to clarify these relationships should be on the financial professional, not the investor.

Panel 2: Discussion Regarding the Commission’s Proposed Form CRS Relationship Summary, including Effective Disclosure and Design

Dale Brown, President & CEO, Financial Services Institute

Brown discussed how Form CRS could impact financial advisers and their clients. Brown stated that more disclosure does not necessarily result in better disclosure, and that investors are most likely to read disclosures that are simple, present key information up front, and have a pleasing design. Brown noted that the SEC has significant expertise in designing disclosures and should be able to maximize effectiveness. Brown said that an investor-focused approach is essential to creating a functional, fair disclosure document, and suggested a two-tier disclosure model with a simple disclosure with the most critical information, supplemented by more detailed disclosures online or in paper format. Brown stressed that the importance of a client’s relationship with their adviser should not be underestimated, and what is most important in the disclosure form is the follow-up conversations it prompts and facilitates.

David Certner, Legislative Counsel and Director of Legislative Policy for Government Affairs, AARP

Certner called for a clear, enforceable standard that would provide investor protection, noting that investors want advice in their best interest. Certner called the proposed Form CRS disclosure “unclear,” saying it does not provide a practical definition of a best interest standard or how it may differ from a fiduciary standard. Certner expressed concern that the disclosure may further confuse investors or provide them with a “false sense of security.” Certner commended the SEC for its proposed restrictions on titling, saying that retail investors should be empowered to make financial decisions. Certner said the disclosure Form CRS should be short, simple, and easy to understand, avoiding technical jargon and highlighting key information on only one page, with secondary data also available in supplemental documents. Certner said the proposal was difficult to fully evaluate before investor testing has been completed, but past testing has shown it is difficult to communicate such complex financial information in a way investors can understand.

Susan Kleinmann, Founder and President, Kleinmann Communication Group, Inc.

Kleinmann explained her work, “making disclosures work for consumers,” in which she has developed and tested numerous model disclosures. Kleinmann noted a number of principles to keep in mind while designing the Form CRS disclosure, including that readers tend to skim information, the importance of how information is organized on the page, anticipating what questions will be asked by the consumer, and the short attention span of readers. Kleinmann expressed that disclosures have to be simple but meaningful, and that putting them in the right context is essential for readers to understand the implications. Kleinmann explained the importance of investor testing, and that good disclosures encourage consumers to ask questions, build meaning, and apply the information they learned.

Joe Carberry, Senior Vice President of Corporate Communications, Charles Schwab & Co., Inc.

Carberry expressed his firm’s long-held support of a common standard of care for broker-dealers and investment advisers, and the importance of preserving investor choice regarding when to receive and how to pay for advice. Carberry said that it is imperative that clients understand their relationship with their investment professional, but expressed concerns that Form CRS could add to investor confusion rather than alleviate it. Carberry noted that for it to have its intended effect, customers first and foremost have to want to read it, and the form must therefore present complex information in layers in a clear, transparent, intuitive way that avoids jargon. Carberry said many investors overlook information that they feel is too complex or lengthy, so the form must be simple and not include any extraneous information. Carberry said that Charles Schwab has developed a one-page prototype that incorporates these ideas, which would accomplish the proposal’s intent while providing access to more information if investors want it.

Discussion

Roper asked if there should be different forms for different account types. Carberry replied that Schwab’s protype form achieves this, and can be adjusted, while Form CRS tried to fit too much information into a four-page document. Kleinmann replied that it is important for consumers to know there are other options available, rather than only seeing the disclosures for their account type.

Silvers commented that it is important to clarify what the SEC is trying to communicate and what it will be policing, as well as clarify the difference between a fiduciary and best interest standard. Certner said that both consumers and financial professionals need to clearly understand the rules, and that when the rules are clear upfront, it mitigates the need for enforcement after the fact. He continued that unclear standards will result in years of litigation and arbitration. Carberry said that what a client should expect from the relationship is one of the most important pieces of the discussion from the client perspective, and that disclosures should be narrowed to include specific expectations. Roper added they are attempting to develop simple disclosures for complex issues, and every sentence will need to be layered with opportunities to access more information.

Commissioner Hester Pearce stressed the need for a plain, simple disclosure, and asked if it would be beneficial for the SEC to undertake independent investor education. Kleinmann said it was critical that people understand financial terms and make those definitions accessible. Certner said that while many people may not take the time to read them, more investor education tools should be made available.

Subcommittee Reports

The IAC reported its recommendations out of committee.

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