Regulation Best Interest – A Junk Food DietAdvisor Perspectives
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Gary Cohn, former economic advisor to President Trump, told The Wall Street Journal in February 2017 that the DOL Rule was “a bad rule.” His point on fiduciary duties then is as incisive as ever today. Translated to language of our time, with respect to the SEC’s proposed regulation best interest (RBI), ”It’s okay to pig out on junk-food investments.”
The heart of RBI is its compliance and ethics program as required in written policies and procedures. Federal securities regulations were conceived as a code of ethics in 1933 by President Roosevelt to be, ”simple enough for the public to understand.” The Advisers Act of 1940 reflects this vision; the Supreme Court affirmed it in 1963 as a federal fiduciary duty for advisers.
RBI should have required robust due care and loyalty duties. It doesn’t. The Institute does not support RBI as is. Its major shortcomings require reengineering to get to a real best interest fiduciary standard.
First, rigorous language must reflect retail investors’ recognized shortcomings and the debilitating impacts of conflicts. The DOL Rule description of best interest is an excellent model:
Investment advice is in the ‘‘Best Interest’’ of the investor when the Adviser and Financial Institution providing the advice act with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity….with out regard to the financial or other interests of the Adviser, Financial Institution or any Affiliate, Related Entity, or other party.
Second, policies and procedures must apply the principles and deal with conflicts. Since 1933 we have learned again and again that casual disclosure alone doesn’t cut it. It fails to mitigate the debilitating harms of material conflicts. The Advisers Act of 1940, informed by common law, requires far more. This includes:
- Disclosures must be affirmative and must include “specific facts.” The SEC emphasizes that conflicts must be disclosed “with sufficiently specific facts so that the client is able to understand (them) … and can give informed consent to such conflicts or practices or reject them.”
- Disclosures must be understood. How the disclosure is written and delivered matters. The broker or adviser is responsible for it to be understood by the client. Disclosure must “Lay bare the truth … in all its stark significance,” Justice Cardoza wrote. The SEC noted, “In the Matter of: Arlene W. Hughes,” there is no one appropriate disclosure method, no “one size fits all” because “The method and extent of disclosure depends on the particular client involved.”
- Informed consent must be attained. Written client consent must be “clear and specific to the transaction” and “intelligent, independent and informed.”
- The transaction must be fair and reasonable. Even with client consent, “the recommendation must be fair and reasonable,” as Professor Tamar Frankel writes. “Courts will generally not enforce an unfair and unreasonable bargain.”
Read the full article here by Knut A. Rostad, Advisor Perspectives