Off-key Regulation: Examining the Sec's and the Dol's Dissonant Regulation of Broker-dealers

• Citation: Vol. 68 No. 2
• Publication year: 2018

Off-Key Regulation: Examining the SEC's and the DOL's Dissonant Regulation of Broker-Dealers

Richard J. Kubiak

OFF-KEY REGULATION: EXAMINING THE SEC'S AND THE DOL'S DISSONANT REGULATION OF BROKER-DEALERS

Abstract

In 2016, the Department of Labor (DOL) forecasted that conflicted investment advice provided by broker-dealers may cause IRA investors in the mutual funds segment alone to lose upwards of $189 billion over the next ten years and $404 billion over the next twenty. In the same year, the DOL under the Obama Administration issued a final rule, known as the "fiduciary rule," that aimed to prevent losses due to conflicted investment advice by expanding the meaning of "fiduciary" as defined in the Employee Retirement Income Security Act of 1974 (ERISA). This rule would have required broker-dealers who provide personalized investment advice to satisfy fiduciary standards of conduct, rather than the currently enforced, less stringent suitability standard.

But after nearly a year and a half of an uncertain fate under the Trump Administration, the rule was vacated in March 2018 by the Fifth Circuit, which held that the DOL exceeded its authority under ERISA in promulgating the rule. With the Trump-era DOL choosing not to appeal the decision, and third-party efforts to do so failing, the rule is officially dead. And with the DOL's efforts to elevate to fiduciary status those broker-dealers who provide personalized conflicted investment advice to investors halted, the Securities and Exchange Commission (SEC) is now the lone agency working to promulgate a standard that could help save retirement investors billions.

After surveying the origins and development of federal securities law and current legislation and regulation governing both broker-dealers and investment advisers, this Comment argues that the SEC should impose a uniform fiduciary standard on broker-dealers and investment advisers who provide personalized investment advice. It also argues that the SEC should collaborate with the DOL to create interagency enforcement guidelines, which will help to resolve the growing tension between the SEC's and the DOL's regulatory agendas and ultimately better protect investors. Until the SEC acts, retirement investors will continue to suffer unnecessary losses on their investments.

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Introduction.............................................................................................371

I. Overlap and Divergence: The Regulatory Framework Governing Broker-Dealers and Investment Advisers..........374

A. The Securities and Exchange Commission ............................... 375

1. The Development of Federal Securities Regulation and the Creation of the SEC............................................................ 376
2. The SEC's Authority to Impose Fiduciary Obligations...... 378
3. Enforcement by the SEC..................................................... 382
4. The Financial Industry Regulatory Authority .................... 383

B. The Department of Labor ......................................................... 385

1. The Development of Retirement Investment Regulation Prior to ERISA.................................................................... 386
2. The DOL's Authority to Impose Fiduciary Obligations ..... 388

a. An Overview of the Retirement Accounts Regulated Under ERISA ............................................................... 388
b. Who Qualifies as a Fiduciary Under ERISA ............... 390
c. Regulation by the DOL After ERISA ........................... 392

3. Enforcement by the DOL .................................................... 395

II. Effects and the Affected: Problems Arising from the Regulatory Framework..............................................................396

A. The Problem for Investors ........................................................ 397
B. Problems for Financial Service Providers and the Federal Government .............................................................................. 399

III. Fine-Tuning: Harmonizing Regulation of Broker-Dealers and Investment Advisers.............................................................401

A. Promulgation of a Uniform Fiduciary Standard by the SEC ... 401
B. Collaboration Between the SEC and the DOL ......................... 403

Conclusion.................................................................................................405

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Introduction

In February 2015, the Council of Economic Advisers (CEA) reported that retirement investors lose approximately $17 billion each year due to receiving investment advice from broker-dealers who have a conflict of interest.¹ The CEA also reported that affected investors lose approximately 1% in investment returns annually.² A year later, in April 2016, the Department of Labor (DOL) estimated that underperformance due to conflicted investment advice could cause individual retirement account (IRA) investors in the mutual funds segment alone to lose up to $189 billion over the next ten years and $404 billion over the next twenty.³

To mitigate these losses, the DOL under the Obama Administration promulgated a final rule, known as the "fiduciary rule."⁴ The primary purpose of this rule was to prevent broker-dealers from providing investment advice when they have a conflict of interest;⁵ in other words, the fiduciary rule aimed to prevent broker-dealers from providing investment advice that is influenced by their ability to profit, not their customers' ability to do so. The practical consequence of this rule would have been to elevate broker-dealers, who usually must adhere to a lower standard of conduct, known as the suitability standard, to fiduciary status.⁶ As fiduciaries, broker-dealers would have been required to act in their customers' best interest, as opposed to an interest suitable to their customers, which is the current standard.⁷

The applicable date of the fiduciary rule was originally scheduled for April 2017.⁸ But in early February 2017, just weeks after taking office, President Trump signed a memorandum calling on the DOL to reassess the Obama Administration's fiduciary rule.⁹ Specifically, President Trump directed the

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DOL to review (1) whether the final rule was consistent with the policies of his Administration, and (2) how it would affect retirement investors' access to financial advice.¹⁰ To provide more time to conduct its analysis, the DOL delayed the effective date for full implementation of the rule and its exemptions from January 2018 to July 2019.¹¹

President Trump's memorandum and the DOL's ensuing delay in implementing the fiduciary rule as passed not only afforded the DOL additional time to assess the merits of the fiduciary rule, but also had two additional consequences. First, it provided the courts more time to determine whether the DOL exceeded its authority under the Employee Retirement Income Security Act of 1974 (ERISA) in promulgating the fiduciary rule. Although the Tenth Circuit had upheld the fiduciary rule just days earlier,¹² the Fifth Circuit vacated the rule in toto in mid-March 2018.¹³ The DOL had until the end of April to file an appeal, but it chose not to,¹⁴ and third-party efforts to intervene were denied by the Fifth Circuit.¹⁵ Thus, the fiduciary rule is officially dead, halting the DOL in its tracks and forcing other interested parties, like academics and professional interest groups, to rethink their arguments either for or against the DOL promulgating its fiduciary rule.¹⁶

Second, the delay afforded the Securities and Exchange Commission (SEC) additional time to consider the merits of imposing a uniform fiduciary standard that could apply to all broker-dealers who provide personalized investment

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advice.¹⁷ The rule being vacated cleared the slate for a possible SEC rule unimpeded by the DOL's fiduciary rule. Indeed, only a month after the fiduciary rule was initially vacated, the SEC proposed multiple rules in mid-April 2018, one of which was called Regulation Best Interest.¹⁸ The SEC's movement here was and is significant because, while the DOL believed it had the authority to modify the standard of conduct for financial advisers of nearly $19 trillion in retirement assets under ERISA¹⁹ until the Fifth Circuit rejected such a statement of authority, the SEC's authority to regulate financial advisers is far greater, covering nearly $67 trillion in investment assets.²⁰ Academics and professional interest groups have also debated the merits of an SEC-imposed uniform fiduciary standard.²¹

Despite the significant amount of literature dedicated to analyzing whether the DOL fiduciary rule was valid or whether the SEC should promulgate its own uniform fiduciary standard, scholars have not identified how the SEC and DOL can collaborate to resolve their overlap in regulatory authority and failed efforts to diverge in policy. This Comment argues for collaboration between the agencies as the means for resolving the growing tension between their regulation of broker-dealers and investment advisers.

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This Comment proceeds in three Parts. Part I surveys the origins and development of federal securities law and the current legislation and regulation governing both broker-dealers and investment advisers. It explains how the evolution of securities regulation and financial markets has resulted in a convergence in authority to regulate broker-dealers and investment advisers between the SEC and DOL. It also explains how the DOL's fiduciary rule encroached on and conflicted with the SEC's existing authority and policy, creating a divergence in policy until the fiduciary rule was struck down. Part II then identifies the primary problems stemming from the resultant, still-disjointed regulatory framework, including losses suffered by investors, investor confusion, and rising compliance costs for financial service providers.

Finally, Part III observes that changes in the investment...