All’s quiet on the Reg BI front

The SEC has been intense about ESG and wait-and-see on Reg BI. But new Enforcement Director Gurbir Grewal supported New Jersey's fiduciary rule and may put teeth in the broker advice standard.

If you’re into sustainable investing, you must be thrilled with the Securities and Exchange Commission.

In his first three months in office, SEC Chairman Gary Gensler has given numerous speeches about the importance of environmental, social and governance factors in the investment climate. He has put on the SEC’s agenda rule proposals on climate risk and human capital reporting.

But if you’re into investment advice reform, you may be feeling a bit neglected by the SEC.

Regulation Best Interest, the broker advice standard, went into force last June. After more than a year of operating under Reg BI, we don’t know to what extent brokerages have changed their advice practices to ensure that their registered representatives are not placing their own revenue desires ahead of their customers’ interest in investment returns.

The brokerage industry maintains Reg BI is much stronger than the previous suitability standard. Investor advocates asserted that Reg BI was too weak to curb brokers’ conflicts of interest.

It likely will take a good while longer to know who is right.

The measure was the centerpiece of former SEC Chair Jay Clayton’s agenda. Gensler will not rip it up and start over. Rather, he told lawmakers when asked at an online congressional hearing, the agency will use guidance, examinations and enforcement to ensure the rule actually protects investors.

But much remains unanswered about Reg BI. For instance, “best interest” is an amorphous term, and what qualifies as “mitigation” of conflicts remains in the eye of the beholder.

“Reg BI urgently needs to offer real guidance to address material issues which remain unclear or undefined,” said Knut Rostad, president of the Institute for the Fiduciary Standard. “Start with ‘best interest’ or ‘mitigation.’ If Reg BI is to be credible, this should not be a several-year process.”

The SEC could take a page out of its ESG playbook to shape Reg BI, Rostad said. For instance, among the agency’s priorities are defining what ESG means and developing metrics for measuring ESG factors.

“Chairman Gensler and [Republican] Commissioner [Hester] Peirce agree on the need for specificity,” Rostad said. “This is important. Apply the same principle to Reg BI, and we are halfway there.”

PUTTING TEETH IN REG BI?

Gensler already has made a major decision that likely will affect how Reg BI evolves. In late June, he appointed New Jersey Attorney General Gurbir S. Grewal to head the agency’s Division of Enforcement.

Grewal is Gensler’s second enforcement director. The first, Alex Oh, stepped down after a few days due to complaints about her conduct while defending Exxon against allegations surrounding its operations in Indonesia. Oh, a former prosecutor, was criticized by investor advocates for her long-time work representing corporate clients.

In selecting Grewal, Gensler went in a completely different direction. Grewal has served as New Jersey AG for more than three years. Previously, he was a county prosecutor and an assistant U.S. attorney. He only worked in private practice for about seven years.

If the effectiveness of Reg BI depends on how it’s enforced, Grewal is uniquely qualified for the job. He was New Jersey AG when the state’s Bureau of Securities, a part of the AG’s office, proposed a fiduciary rule. State regulators said they needed to pursue their own advice standard because they didn’t have confidence in Reg BI.

Grewal’s support was instrumental for pushing ahead with New Jersey’s fiduciary rule, said Laura Posner, a partner at Cohen Milstein Sellers & Toll. A final rule has not yet been released.

“I believe he understands [investment advice] issues well and will not shy away from enforcing Reg BI to the fullest extent possible,” said Posner, who served as chief of the New Jersey Bureau of Securities before Grewal was AG but worked with him when he was an assistant U.S. Attorney. “I know him to be incredibly smart, conscientious and not afraid of a fight.”

He’s joining the SEC when the agency is expecting more regarding Reg BI compliance than the “good faith” efforts it sought during the pandemic.

“They’re interested in high-cost, complex products and situations where there is significant trading activity in accounts,” said Erica Gerson, a partner at Steptoe & Johnson. “They’re looking at whether that activity is in the client’s best interest and complies with the rule. Where there is investor harm, they will not shy away from enforcing Reg BI.”

Even though Gensler is not devoting as much time to Reg BI as Rostad would like, Rostad’s confident the commission under his leadership will elevate investor protection.

“This is the most investor-centric commission in 20 years,” Rostad said. “We are in a historic moment.”

History has quite a bit of bandwidth. There should be room for both Reg BI and ESG at the SEC.