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My Comment Letter to the SEC

(submitted via:; comments due by August 7, 2018)

To the Commission:

I’m commenting on the proposed disclosure requirements, also known as the “Relationship Summary Disclosure” articulated in SEC Proposal 34-83063 (also Release No. IA-4888, File No. S7-08-18), recommending modifications to certain sections of the disclosures that would be made by broker-dealers and investment advisers. 

The proposed disclosure language for broker-dealers, under “Standard of Conduct,” would say “We must act in your best interest and not place our interests ahead of yours when we recommend an investment or an investment strategy involving securities.”

However, there is no evidence that the Commission intends to actually hold broker-dealers to this standard.  In fact, there is abundant contrary evidence in your  accompanying regulatory Proposal.

According to SEC Proposal 34-83062, a broker who sells an annuity with a fat commission is held to a standard that is far from fiduciary; he must (page 44):

“(1) understand the potential risks and rewards associated with the recommendation, and have a reasonable basis to believe that the recommendation could be in the best interest of at least some retail customers; (2) have a reasonable basis to believe that the recommendation is in the best interest of a particular retail customer based on that retail customer’s investment profile and the potential risks and rewards associated with the recommendation…” (emphasis added)

The actual definition of a “best interest” standard is further enumerated in terms which seem to be far from looking out for the best interests of the customer:

“the best interest obligation would allow a broker-dealer to recommend products that may entail higher costs or risks for the retail customer, or that may result in greater compensation to the broker-dealer than other products, or that may be more expensive, provided that the broker-dealer complies with the specific Disclosure, Care, and Conflict of Interest Obligations.” (page 58)

On page 47-48, the Proposal says that its drafters followed DOL’s lead in its fiduciary formulation, except that they replaced the DOL rule’s “making recommendations without regard to your own interests” to more lenient terminology, because

“we were concerned that inclusion of the “without regard to” language could be inappropriately construed to require a broker-dealer to eliminate all of its conflicts (i.e., require recommendations that are conflict free)…” 

It seems clear here and elsewhere that the SEC specifically does NOT want to require brokers and sales agents to provide conflict-free advice.  (One wonders how that can be reconciled with the “best interest” terminology.) 

Moreover, the Proposal specifically endorses sales commissions (page 38) which represent an embrace of conflicts of interest in the customer/broker-dealer relationship—conflicts which have, in the past, led to incidences of churning and sales of unsuitable investments.  And on pages 53-54, the Proposal further clarifies that the proposed Regulation Best Interest would not, per se, prohibit a broker-dealer from transactions involving conflicts of interest, such as the following:

Charging commissions or other transaction-based fees; 

• Receiving or providing differential compensation based on the product sold; 

• Receiving third-party compensation; 

• Recommending proprietary products, products of affiliates or a limited range of products; 

• Recommending a security underwritten by the broker-dealer or a broker-dealer affiliate, including initial public offerings (“IPOs”); 

• Recommending a transaction to be executed in a principal capacity; 

• Recommending complex products; 

• Allocating trades and research, including allocating investment opportunities (e.g., IPO allocations or proprietary research or advice) among different types of customers and between retail customers and the broker-dealer’s own account;

• Considering cost to the broker-dealer of effecting the transaction or strategy on behalf of the customer (for example, the effort or cost of buying or selling an illiquid security); or 

• Accepting a retail customer’s order that is contrary to the broker-dealer’s recommendations.”

In addition, the brokerage community itself, in its legal arguments against being held to the standards of the DOL Rule, has argued that its representatives are fundamentally in a sales relationship with their customers—NOT an advice relationship.  Is that not relevant disclosure to the potential customer who is receiving recommendations from a broker-dealer representative?

Finally, if a customer dispute is taken to mandatory arbitration, broker-dealers and broker-dealer representatives routinely claim that they are simply acting in a sales capacity.  The FINRA arbitration system does not recognize a “best interest” or “fiduciary” standard, or that the relationship was predicated on advice and trust—even though broker-dealer sales literature and advertising intentionally describe their services as advice-based.

For these reasons, I would recommend that the disclosure language cited above, under “Standard of Conduct” for broker-dealers, be amended to:

“We are not required to act in your best interest, and despite any implied claims to the contrary, we intend to engage in a sales relationship with you, where our recommendations not only may not be in your best interests, but the compensation incentives will actually provide our representatives with incentives to give advice that will be in our best interests rather than yours.”

I also recommend that the disclosure language relating to investment advisory firms be amended.  On page 54, and again on page 94, the Proposal would include the following wording:

“We are held to a fiduciary standard that covers our entire investment advisory relationship with you.  For example, we are required to monitor your portfolio, investment strategy and investments on an ongoing basis.”

I think the Commission well understands that this second sentence is at best an incomplete, and more accurately a misleading definition of the fiduciary concept.  I recommend that that second sentence be replaced by terminology that would give the consumer a much better understanding of the obligation the advisor is operating under:

“A fiduciary standard is a much higher obligation to serve the interests of consumers and clients than the sales standard imposed on broker-dealers and sales agents, and requires not only an obligation to put your interests ahead of others, but also to exercise prudence and professional judgment when making investment and financial recommendations.  And the advisor who is not registered with a broker-dealer has renounced the conflict of interest represented by sales commissions where investment companies pay (often generously) the broker-dealer and its representatives to sell its products.  You may also receive valuable financial planning or non-investment-related advice as part of the services paid for by your asset-based fee.”

I believe that these simple changes in the disclosure would greatly clarify, in the mind of most consumers, the differences in regulatory obligations and business practices between broker-dealers and advisors.

Let me make an additional recommendation.  Both Proposed Rule 34-83062 and Proposed Rule 34-83063 (see pages 164-176 and particularly pages 171-176) recommend that broker-dealers and their representatives be prohibited from calling themselves “advisors” or “advisers”—including various permutations of the term (“financial advisor;” “investment advisor” etc.).  Although this is certainly an improvement over the current situation, I believe that simply prohibiting “advisor” is not likely to have the intended effect.  There are many nearly-synonymous terms in the marketplace which brokers and sales agents could freely adopt to disguise their true relationship with the consumer, including “financial planner,” “wealth manager,” and “vice president of investments.”

Others have suggested that these other terms be regulated under prohibitions similar to what you’re proposing with “advisor” or “adviser,” but the Commission has recognized how difficult it would be to prohibit a broad range of terms, particularly since there is nothing in the Investment Advisers Act that would provide it with this authority.

Instead, I recommend that representatives of broker-dealers be required to identify themselves as “brokers” on their business cards and in their advertisements and sales literature UNLESS they register as RIAs with the Securities and Exchange Commission.

I hope you were sincere when you stated, in Rule 34-83062, that there is a danger in creating a misleadingly lofty label and applying it to standards that are lower than the label would imply.  From pages 20-21:

“Any confusion regarding the standards of conduct that apply may only enhance the potential for harm from broker-dealer conflicts of interest, as this confusion results in retail customers mistakenly relying on those recommendations as being in their ‘best interest.’”

Perhaps by accident, the Commission would seem to be adding to the confusion with its initial Proposal.  But with several small changes, the confusion could be ameliorated and the relationships between service provider and consumer clarified in ways that would be understandable to most Americans.

I thank the Commission for its attention.