Another election, another change in investment advice regulation

Fiduciary duty? Best interest? They’re ultimately political decisions

When President-elect Joe Biden is inaugurated in January, regulatory policies governing investment advisers and brokers likely will change. It’s a process that is becoming familiar. Oversight of financial professionals differs based on whether a Democrat or Republican occupies the White House. That’s because, at their core, regulatory decisions are political ones.

I’d like to start my first column for InvestmentNews by making a modest ask of our readers: Let’s drop the pretense that protecting investors is a nonpartisan issue.

Several of the most important regulations affecting advisers, brokers and their clients were adopted by the Securities and Exchange Commission on split votes during the Trump administration, when the SEC had a Republican majority.

SEC Chairman Jay Clayton is a political independent appointed by Trump. But he usually sided with the two SEC GOP commissioners when a consensus was not reached on a rule.

The SEC is headquartered in Washington, D.C., where politics is in the DNA of just about every entity.

“Commissions are political,” said Aaron Cutler, a partner at Hogan Lovells who was once an aide to former House Majority Leader Eric Cantor, R-Va. “They’re run by the party in power. Folks here in D.C. are used to it.”

Like almost every other topic in Washington, investment advice policy mostly divides Democrats and Republicans. That’s not to say that one party cares more about investors than the other. But they have sharply different ways of reaching that goal.

Republicans generally tend to trust market forces to benefit investors. The GOP emphasizes disclosure to ensure that investors can determine for themselves what’s best for them.

Democrats tend to be more paternalistic by emphasizing the government’s role in investor protection through regulation and the courts. Generally, they favor reducing conflicts of interest by attacking them directly.

For instance, the Obama administration’s Department of Labor promulgated a tough fiduciary rule that included a private right of action. But the Trump administration abandoned that rule after a federal appeals court overturned it rather than appeal, and it was vacated.

“This kind of stark split along political lines is atypical historically [for the SEC]. There’s not even a shared reality anymore.”

Howard Fischer, partner, Moses & Singer

The SEC stepped into the breach during the Trump administration and produced Regulation Best Interest, the new broker standard that replaced suitability.

The regulators acted on a 3-1 vote, with the Democrat on the commission at the time opposing it. If the commission had been at full strength with two Democrats, the vote would have been 3-2. The decision to move forward with Reg BI without a Democrat on board was essentially a political one.

Clayton said the time had come for the agency to raise the broker advice standard and better align it with the fiduciary duty that governs advisers, which he asserts is what Reg BI does. Setting — and advancing — the SEC agenda is the political prerogative of the chair.

In the Biden administration, the SEC will have a 3-2 Democratic majority. It likely will revisit Reg BI — taking a tougher enforcement approach, if not trying to rewrite it. The agency also will likely reconsider efforts by the Republican-majority SEC to open private securities markets to more ordinary investors.

“An incoming SEC chair has to be as willing to be as partisan to strengthen investor protections as [Clayton] has been to dismantle them,” said Barbara Roper, director of investor protection at the Consumer Federation of America.

WHIPSAW FATIGUE

But those who must answer to regulators in Washington are getting tired of having the rules changed on them every four years. Revamping compliance systems to adhere to new regulations can be costly for financial firms.

“They will balk and say enough is enough,” said James Allen, head of capital markets policy for the Americas at the CFA Institute. “Let’s get to something that is acceptable to both sides.”

Politics also could limit the amount of regulatory change financial advisers will see in the next four years. If the Senate stays in Republican control after Jan. 5 runoff elections for two Georgia seats, it could mean that Biden will have to nominate an SEC chair who is palatable to the GOP and less inclined to rattle the financial industry.

Biden may not choose to battle a GOP Senate over the SEC chair and some other administration positions.

“They’re probably going to pick people who can be confirmed without a lot of effort on their part,” said James Angel, a professor of finance at Georgetown University’s McDonough School of Business. “I’m not seeing a lot in the way of fundamental reform.”

A new SEC chief may want to defuse some of the partisan tension around rulemaking, said Howard Fischer, a partner at Moses & Singer.

“This kind of stark split along political lines is atypical historically [for the SEC],” said Fischer, a former SEC enforcement trial counsel. “There’s not even a shared reality anymore. That’s going to lead a Biden SEC not to be as ideologically motivated as a Clayton SEC was. There is a desire for more consensus.”

That could ultimately help preserve Clayton’s legacy.

“I don’t think there’s going to be a wholesale reversal of Clayton-era rulemaking,” Fischer said.

Unlike a pending DOL fiduciary rule that has yet to go final and is ripe to be immediately overturned by the Biden administration, Reg BI was implemented in June. Its relative longevity may keep it intact for a while.

“It will necessitate at least a few years of practical experience to see what needs to be fixed in Reg BI,” Allen said.

How far and how fast a Democratic-majority SEC goes in revamping Reg BI will, as usual, be a political decision.