United States: Clayton Comes Out Swinging Against Critics Of Regulation Best Interest

In a speech on July 8, 2019, SEC Chair Jay Clayton responded to criticism of Regulation Best Interest, setting out his arguments in a concise, step-by-step rebuttal.5

After a brief summary of Regulation Best Interest ("Reg. BI"), the Form CRS relationship summary, the clarification of a registered investment adviser's ("RIA") fiduciary duty (the "Fiduciary Interpretation") and the interpretation of the "solely incidental" prong of the broker-dealer exclusion under the Investment Advisers Act of 1940 (the "Advisers Act"), Chair Clayton got down to the business at hand:

"Let me now address some of the commentary, or, more specifically, the criticism and misinformation, I alluded to at the outset. I believe that much of this criticism—which is focused broadly on the extent of the investor protections under Reg. BI and our Fiduciary Interpretation—is false, misleading, misguided, and unfortunately, in some cases, is simply policy preferences disguised as legal critiques."

Complaint No. 1: The standard of conduct imposed on broker-dealers by Reg. BI will not do enough to protect retail investors.

Chair Clayton Response: In a swift one-two punch, Chair Clayton emphasized that Reg. BI substantially enhances the standard of conduct for broker-dealers by (1) establishing a standard of care for transactionbased advice that draws upon principles underlying the investment adviser fiduciary duty, and (2) being workable for broker-dealers. Under Reg. BI, (1) whether a retail investor chooses a broker-dealer or an investment adviser (or both), the recommendation or advice is required to be in the best interest of the retail investor and cannot place the interests of the firm or the financial professional ahead of the interests of the retail investor, and (2) the ability to choose between a broker-dealer transaction-based model and an investment adviser portfolio-based model—and choose among the various iterations and combinations of each—will be preserved.

Complaint No. 2: Reg. BI doesn't eliminate all conflicts of interest.

Chair Clayton Response: Calling this criticism "misguided," Chair Clayton acknowledged that there are conflicts of interest inherent in all principal-agent relationships, and the broker-customer relationship and the investment adviser-client relationship are no exception. However, Reg. BI recognizes that these conflicts exist, and requires that firms address those conflicts.

Complaint No. 3: Reg. BI fails because "best interest" is not defined and it doesn't require the broker-dealer to recommend the "best" security.

Chair Clayton Response: Reg. BI takes a principles-based approach, rather than a prescriptive approach, in determining what is in the best interest of the retail customer. Whether a broker-dealer has acted in the retail customer's best interest will turn on an objective assessment of the facts and circumstances. Neither brokerdealers nor investment advisers are required to recommend the "best" security, something that may only be known in hindsight.

Complaint No. 3: The fiduciary interpretation weakens the existing RIA fiduciary duty by not requiring RIAs to "put clients first."

Chair Clayton Response: "This claim is flatly wrong." The critics are again swinging at air here, in that the Fiduciary Interpretation reaffirms the existing fiduciary protections under the Advisers Act, as stated by the U.S. Supreme Court in SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180 (1963). The core principle has always been that the adviser must at all times serve the best interest of its client and not subordinate its client's interest to its own, which principle the Fiduciary Interpretation reaffirms.

Complaint No. 4: The fiduciary interpretation weakens the existing RIA fiduciary duty by not requiring RIAs to avoid all conflicts.

Chair Clayton Response: "There is no legal or regulatory basis for this claim." Chair Clayton explained that some critics cited an instruction in Form ADV, adopted by the SEC in 2010, as the basis for a "no conflicts" requirement for RIAs. However, this would be a fundamental change from the existing legal standard for an RIA's fiduciary duty, as stated in SEC v. Capital Gains.

Complaint No. 5: The standards of conduct under Reg. BI and the Fiduciary Interpretation can be satisfied by disclosure alone.

Chair Clayton Response: Forcing the critics into a corner, Chair Clayton said that this claim "reflects a fundamental misunderstanding of how the independent component obligations of Reg. BI operate and a misconception of the investment adviser's fiduciary duty."

In order to satisfy the General Obligation of Reg. BI, a broker-dealer must satisfy all four of the component obligations, not just the Disclosure Obligation.6 To satisfy the Conflict of Interest obligation, conflicts will, in many case, have to be mitigated. In some cases, they will have to be eliminated. Even if a conflict can be addressed through disclosure, including the Care Obligation, which applies to all recommendations, whether a broker-dealer has disclosed, mitigated or eliminated the conflict of interest.

RIAs have an obligation to act in the best interest of the client, which encompasses a duty of care and a duty of loyalty. The duty of care cannot be satisfied by disclosure alone.

Complaint No. 6: Reg. BI is deficient because it does not require broker-dealers to monitor a customer's account or impose an ongoing duty.

Chair Clayton Response: Chair Clayton called this argument "fundamentally flawed" and reflecting a misunderstanding of how federal law applies. One of Reg. BI's goals is to preserve access to different types of services, and investor choice. Forcing broker-dealers to provide ongoing monitoring services lessens choice and increases investor costs. More fundamentally, imposing an ongoing monitoring requirement on brokerdealers would subject the broker-dealer to regulation as an RIA and also vitiate the "solely incidental" prong of the broker-dealer exclusion under the Advisers Act.

Complaint No. 7: Form CRS will not address investor confusion regarding the differences between brokerdealers and RIAs.

Chair Clayton Response: Chair Clayton deflected this shot by pointing to the extensive feedback, investor testing and SEC Staff expertise involved in creating Form CRS and the enhancements to the form made after the proposing release. Investors are confused about the roles of broker-dealers and RIAs; Form CRS is a substantial improvement over existing retail disclosures. According to Chair Clayton, Form CRS provides an unprecedented level of transparency and comparability across SEC-registered RIAs, broker-dealers and dual registrants.

Conclusion

Chair Clayton, by a knockout.

5 Chair Clayton's speech is available at: https://bit.ly/32UdIKo

6 For a more detailed discussion of Reg. BI, please see our legal update at: https://bit.ly/2Osrlxc.


Originally published in REVERSEinquiries: Volume 2, Issue 7.
Click here to read the articles in this latest edition.


Visit us at mayerbrown.com

Mayer Brown is a global legal services provider comprising legal practices that are separate entities (the "Mayer Brown Practices"). The Mayer Brown Practices are: Mayer Brown LLP and Mayer Brown Europe – Brussels LLP, both limited liability partnerships established in Illinois USA; Mayer Brown International LLP, a limited liability partnership incorporated in England and Wales (authorized and regulated by the Solicitors Regulation Authority and registered in England and Wales number OC 303359); Mayer Brown, a SELAS established in France; Mayer Brown JSM, a Hong Kong partnership and its associated entities in Asia; and Tauil & Chequer Advogados, a Brazilian law partnership with which Mayer Brown is associated. "Mayer Brown" and the Mayer Brown logo are the trademarks of the Mayer Brown Practices in their respective jurisdictions.

© Copyright 2019. The Mayer Brown Practices. All rights reserved.

This Mayer Brown article provides information and comments on legal issues and developments of interest. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions