Wall Street is known for making money by selling risky investments with complicated names. Some examples: equity indexed annuities, structured notes and leveraged inverse exchanged traded funds.
The days of marketing such products aren’t necessarily coming to an end. But things could get more challenging if regulators require financial firms to make sure whatever they are peddling is in their clients’ interests.
Last week, the U.S. Securities and Exchange Commission took the first step by proposing a new "best-interest" standard for brokers. At a high level, the strictures -- laid out in hundreds of pages of text -- are designed to root out sales practices that investor advocates say encourage firms to steer customers into inappropriate investments that boost broker compensation.
While the SEC has long been urged to do more to address broker misconduct, the issue started boiling over in 2016 when Barack Obama’s Labor Department approved tough conflict-of-interest rules. The pressure for SEC Chairman Jay Clayton to do something increased last month when a federal appeals court struck down the Labor regulations, putting them in legal limbo.
If the SEC’s plan takes effect, brokers would be required to disclose and mitigate a range of conflicts. Brokers would also be prohibited from using titles that give customers the impression that they have a fiduciary duty -- the requirement that they put clients’ interests ahead of their own. Investment advisers have long had a fiduciary duty, and the Obama-era rules sought to extend that obligation to brokers who handle retirement accounts.
But there is a lot of confusion about what the SEC’s regulations would actually require, and the head-scratching isn’t just happening on Wall Street. At the SEC’s April 18 meeting, Republican and Democratic commissioners expressed concern that the agency had left things too vague by failing to make clear what a best interest means.
Here are some key questions about the SEC’s proposal:
What is the SEC’s best-interest standard?
The SEC doesn’t define "best interest." Instead, it lists obligations meant to ensure brokers don’t place their own interests before those of their clients. The SEC said the regulations would also require firms to “establish, maintain and enforce policies” that are designed to spot conflicts and mitigate them.
Taken together, the rules are a step up from the current SEC requirements that specify that brokers offer “suitable” investments. But the proposal isn’t nearly as stiff as a fiduciary duty.
Specifically, the regulations would require brokers to have a "reasonable basis" to believe that a recommendation to buy or sell a security is in the best interest of the customer. The rule, however, doesn’t require brokers to assess what is the best investment. Instead, it says brokers should weigh factors beyond simple costs and financial incentives.