SEC’s ‘best interest’ Reg BI rule fails to live up to initial promise, panel says

Reg BI, the rule adopted by securities regulators five years ago that intended to require brokers to provide a higher standard of care for clients, has not nearly lived up to its promises, leaving regular investors more vulnerable than ever to fraud and abuse by financial advisors.

That was the consensus finding of a recent panel hosted by the Institute for the Fiduciary Standard to mark the quinquennial of the Securities and Exchange Commission’s Reg BI, establishing a “Best Interest,” standard. The enhanced standard for financial professionals was seen as a means to address conflicts of interest, disclosure requirements, and compliance. Reg BI applied to broker-dealers and investment advisors making recommendations to retail customers relating to security sales.

But, to a person, members of the panel detailed continued tragic tales of abuse by financial advisors, notably with retirees as victims, and said there has been a severe lack of enforcement and no measurable reduction in the volume of risky, expensive, and questionable financial products being foisted on to the investing public.

“Almost every week we see an investor come into our office who's lost a substantial amount of their life savings,” said Joseph Peiffer, attorney and president of the Public Investors Advocate Bar Association (PIABA). “They've saved to pay off their house, put their kids through college and build a nest egg all on salaries paid to middle class workers. They've done everything that America has asked of them, and they break down in my office when I explain to them how their investment was lost to conflicted advice, and how a real fiduciary standard does not apply to the advice that they got.”

Peiffer said Reg BI is not a true fiduciary standard.

“The difference between getting conflicted advice and getting true fiduciary advice is the difference between being able to live out your golden years with dignity knowing your hard work has paid off, or being shattered by the reality that by trusting an advisor who did not have a real fiduciary duty leaving you with nothing to show for 30 or 40 years of hard work,” he said.

Coming years may present more challenges

Benjamin Schiffrin, director of securities policy for Better Markets, a nonprofit organization that promotes financial reform, problems with Reg BI enforcement, said while the last five years of Reg BI have been bad, the next five years could be worse.

“[Reg BI] is unlikely to be sufficient to address the risks that the use of new technologies pose for retail investors today,” Schiffrin said. “Reg BI only applies when a broker is making a recommendation, and a recommendation does not necessarily include a broker using digital engagement practices, or the gamification features that broker dealers use to keep investors trading on their platforms.”

Schiffrin said amendments to the rule are needed to ensure brokers must put their customers first whenever they interact with investors by whatever method. A new SEC proposed predictive data analytics rule, which says brokers must eliminate conflicts of interest from their use of technology investor interactions, is a good first step, he said.

Former SEC Commissioner Robert Jackson, Jr., who was the lone vote against adoption of the Reg BI rule in 2019, said most everything he feared about the rule has come true.

“At the time it was adopted, I complained that the standard is so muddled, so vague, that it would be impossible for ordinary investors to know whether or not their financial advisors have put the investor first when they offer financial advice,” he said. “The rule never defines what it requires firms to do to meet a best interest standard. It doesn't say what kinds of harmful conflicts firms are prohibited from engaging in. It's not clear to me whether enough has been done to give firms direction on that. My view was that it was doomed from the start, and it's somehow got even worse than I imagined.”

Reg BI weaknesses, loopholes cited

Panelists also noted that because of enforcement weaknesses and loopholes, even advisors that have been revealed as unscrupulous, leave the investment advisor field and become insurance producers, regulated at the state level.

“Insurance sales is where we see a ton of abuse,” said Peiffer. “The insurance industry makes the securities industry look like a bunch of librarians in some ways. We see some truly bad abuses going on in the insurance space.”

Securities regulators, unsurprisingly, have defended Reg BI and chastised critics. Speaking at a conference in Boston shortly after the regulation was adopted, then-0SEC Commissioner Jay Clayton called the criticisms, “false, misleading, misguided, and is simply policy preference disguised as legal critique.”

But there are some changes in the making and perhaps more on the way, panelists noted. A new Department of Labor Retirement Advice Rule is slated to go into effect in September, but industry trade groups are challenging it in court.

“I think that it solves some of the problems,” Peiffer said. “It's a real fiduciary standard. The DOL rule does plug some gaps and says that if you're going to sell some of these things, like insurance products to people that are retirees or into retirement accounts, then you are subject to a real fiduciary duty. That should clean up a lot of these problems. Whether this court challenge is going to be successful, it really ought not to be.”

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Doug Bailey is a journalist and freelance writer who lives outside of Boston. He can be reached at [email protected].