Fiduciary rule poll: next steps

Author: | Published: 21 Sep 2017
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IFLR speaks with Morrison & Foerster’s Anna Pinedo and Hillel Cohn, who helped compile the questions, to discuss the results of the poll and the best course of action for the fiduciary rule

Anna Pinedo Hillel Cohn

Despite its unpopularity, more respondents feel that the fiduciary rule should be retained than revoked. Why do you think that is?

Anna Pinedo

My view is that, at this point, many firms have committed a lot of resources to the fiduciary rule and compliance with it. They also may have planned their communications with clients when it comes to the rule and so may be reluctant to change course. They may think it is expensive to change course, and may believe that any messaging relating to a change of course of action would be a challenge. I also think it is reasonable to predict, given public statements, that the Securities and Exchange Commission [SEC] will in earnest work on a rule. It may be different in some ways from the existing Department of Labor [DoL] rule, but will be shaped around some kind of broader best interest rule. I think many firms view this as an inevitability of sorts.

Hillel Cohn

I would add that even in Congress now there appears to be a coalescing of views that some type of enhanced standard conduct is required for broker dealers. It just seems that we have gone too far down the road to do a 180 and completely eliminate the concept.

More than 60% of respondents feel that it would be practical to roll back the fiduciary standard required by the DoL rule, even if compliance is now at an advanced stage. Why do you think that the market is so certain that this can be done?


I was a little bit surprised at that outcome of the poll, because it does seem inconsistent with the result of the first question. Congress could pass a bill which would basically put a full stop to the DoL rule and effectively rescind it.

There is no question that there is a legal basis to reverse course. However, I think the practical factors that Anna just cited are going to argue strongly against a complete reversal or revocation of the rule.


I think when some clients talk about the rule, they still believe that there will be some kind of best interest rule or standard. But they find a lot of the prohibited transaction exemptions like the best interests contract agreement and all the paperwork and requirements that go with it very burdensome. Even though they may sort of grudgingly think that there will be a best interest standard or some of them may even support this, they find the DoL rule as currently constructed difficult to navigate, and burdensome from a document and compliance perspective. I think that, during this transition period, they certainly find it easier to function, but they find moving to the ultimate requirements as currently drafted or currently formulated to be challenging.

I would take away from responses, or this response compared to the prior one, that many people are just worried about specific parts of the DoL rule.

There has been a widespread call for the SEC to release a best interest standard that applies to the whole industry, including that which is covered by the current DoL rule. What are your thoughts on this?


I think people that we spoke to would heartily endorse that approach. There is a lot of concern about having different standards: many, many, many clients of broker-dealers have retirement accounts and non-retirement accounts. Trying to apply different standards of care in that context may not be very sensible and may create potential complications which will be eliminated by having a single standard that applies across the board.

What aspects of the current rule do you think this new look best interest standard would likely keep, if any, and what would it shed?


I think the SEC's request for information and the request that the DoL has put out are helpful in terms of giving a road map. One of the centrepieces of the regulation of conflicts sets a fiduciary standard for advisers: they have to disclose conflicts of interest and they seek informed written consent from clients to proceed, and clients are able to opt out.

Something along those lines, which is already part of the DoL rule, is the idea that conflicts of interest have to be clearly and prominently disclosed, and that there should be some contract or agreement between the broker-dealer and the customer. From the SEC's report that they were required to put out by Dodd-Frank in 2011, where they talked about how clearly it was a standard that was higher than the current suitability standard, it does require this consideration of alternative products and fee structures. It goes beyond what is part of the current suitability standard, and those are going to be some of the basics of what we see from the SEC.


I think that is exactly right, and I think it is consistent with the SEC's fundamental charter which is basically to regulate through full disclosure rather than dictate what people should or should not invest in.

If a comprehensive roll-back were to happen, what would be the best way to go about it without there being a direct negative impact for the early adopters of the rule?


It is difficult to believe there will be a complete roll-back. I think what Anna said is likely to be the outcome: there will be some kind of best interest standard – or something akin to a best interest standard – that survives and which is not going to be rolled back. Many of the more onerous provisions that are in the rules adopted by the DoL last year will be substantially revised, trimmed back or eliminated. For early adopters, I think compliance with a best interest standard will probably be something they are going to continue to live with and promote as demonstrating that their interests are consistent with those of their customers. The message is: we are looking out for your best interest Mr. Customer, we are not just salesmen who will sell you whatever we happen to have in our inventory.

There has been little change to the way that smaller, retail retirement accounts have been handled. Respondents have overwhelmingly made no move to change in this regard: what is the benefit of this?


I think it is hard to know. There certainly has been a lot of talk in the industry about changes that are likely to come about if this rule is fully implemented, and this may simply reflect people waiting to see what the final shape of the rule is going to be. It may also be people saying: 'well let's see how it works and if it is too difficult or too expensive to comply for the smaller accounts then we will deal with it at that time'.

Overall, the poll suggests that there has been little in the way of changes made so far, including in internal compensation arrangements and product mix offerings. Do you think that this is because the market is already expecting that the rule will be further delayed or rolled back entirely or another reason?


There is certainly a lot of hesitation to dramatically change business models. There were a lot of smaller firms that were waiting to see what some of the larger wirehouse firms did, and they were waiting to see what would happen with the rule generally.

Determining what constitutes reasonable compensation has been expressed to be the most challenging aspect of complying with impartial conduct standards. What makes this so difficult?


This struck me as an interesting outcome to the poll. I think determining the reasonableness of compensation with respect to a particular product at the firm level is probably not all that difficult . However, I think the internal compensation arrangements are much more challenging in that you basically have systems which were designed to promote sales which now have to be revisited. This is going to be true even if only the impartial conduct standard survives – the systems have to be revisited to make sure that they could not incentivise brokers to push products that are not in the interest of the retail client. My sense is that there is a lot of work to do in that particular area, which may be why this item was flagged as the most challenging aspect of the impartial conduct standards.

Opinion is split on whether to sell proprietary products to retail retirement accounts following the rule's enforcement. Why do you think that this question saw mixed results?


I think that market participants don't know clearly what a proprietary product is. We have been struggling ourselves with trying to understand what the parameters are in identifying a proprietary product.


The definition in the DoL rule is less than clear with respect to what would constitute a proprietary product. There are also some internal inconsistencies in the rule as to how proprietary products would be treated. The scope of what constitutes a proprietary product and the consequences of determining that a particular product is proprietary is an area that clearly, at a minimum, needs some guidance from whichever authority is going to administer the new standard. That's assuming there is a different category of treatment for proprietary products.

How does the market want that principle transaction exemption to be relaxed?


There are many categories of securities that are excluded from the current principal transaction exemption. This would really be disruptive to capital markets as they currently operate. I don't think, from the industry side that there is much debate about the need to significantly expand the scope of products that could be sold under some kind of exemption on a principal basis, or that it is going to be a very important part of any rule going forward.


I have heard lots of clients complain. I am sure there isn't any reason why securities issued by a foreign issuer shouldn't be allowed to be included

Finally, what is your key takeaway from this poll?


I think that it is probably that most people agree to an extent that some standard, be it best interest or fiduciary, is likely to be around. Depending on where you are situated it is probably regarded as almost a necessity or maybe an inevitability.


The most surprising thing to me was the relative lack of steps taken to prepare for the rule. I would have thought there would have been more pro-active activity than apparently there has been.