FINRA CEO Richard Ketchum took issue with the characterization of the current broker-dealer landscape as “caveat emptor.” He said that such narratives are false and not “an accurate starting point to justify a new standard of care” in a recent speech at the 2015 FINRA Annual Conference. Ketchum’s remarks come at a time when the Administration continues to put its weight behind the Department of Labor’s fiduciary proposal. In a speech this week, Jeffrey Zients, the Director of the National Economic Council, said that “[u]nfortunately, for some special interests, the only good rule on conflicts of interest would be no rule at all. That’s not going to happen. Inaction is not an acceptable outcome, when the retirement security of so many Americans is at stake.”
In his speech, Ketchum emphasized the protections available under the current regulatory structure. Ketchum highlighted FINRA’s more than 6,800 cycle, cause, and branch examinations in 2014, arguing that broker-dealers are covered under a “very strong and effective regulatory framework.” He also noted rules relating to recommendation due diligence and suitability, as well as those restricting non-cash compensation; imposing caps on 12b-1 fees and sales loads; requiring disclosure of principal trades, commissions, fees and expenses to customers; and requiring that certain revenue sharing arrangements with mutual funds be disclosed.
In addition to the regulatory protections he highlighted, Ketchum expressed support for the implementation of a best interest standard. He noted that, despite FINRA’s efforts, there are still “unacceptable instances of unsuitable sales of more complex products without the appropriate disclosure to clients,” and some firms approach conflicts on a “haphazard basis.” Additionally, he argued that there is insufficient discussion of IRAs in general to allow investors to make fully informed decisions and that the current state of differing standards between broker-dealers and investment advisers leads to investor confusion.
Ketchum raised several concerns that he believes should derail the DOL’s proposal. He pointed to the contractual mechanism in the proposal in which, in order to fall under an exemption for receiving commission-based compensation, a firm must contractually acknowledge fiduciary status. Ketchum noted several uncertainties in how an arbiter would resolve class actions or arbitrations regarding “whether a recommendation was in the best interests of the customer ‘without regard to the financial or other interests’ of the service provider” or “which compensation practices “tend to encourage” violations of the exemption.” He suggested that such issues may be resolved with “a sharp line prohibiting most products with higher financial incentives no matter how sound the recommendation might be” and “that any higher compensation was directly related to the time and expertise necessary to provide advice on the product.”
While he suggested that the DOL’s concerns over conflicts are valid, he argued that “the uncertainties stemming from contractual analysis and the shortage of useful guidance will lead many firms to close their IRA business entirely or substantially constrain the clients that they will serve.” Additionally, applying a different legal standard to 401(k)s and IRAs compared to other accounts does not match how many investors plan for retirement using both tax-advantaged and other accounts. Rather, effective regulation would require the application of a consistent standard.
Ketchum argued that the SEC should be the agency to implement a best interests standard and that the standard should focus on three basic tenets: “active identification and management of firms’ conflicts, dramatically improved disclosure of risks associated with the product and product-related fees, firm and third party incentives, and more effective management of the compensation incentives to registered persons.” At a basic level, the standard should “make clear that customer interests come first and that any remaining conflicts must be knowingly consented to by the customer” and the standard should begin with know-your-customer and suitability standards. Ketchum advocated that firms should receive sufficient guidance so that they can easily comply with requirements and that firms also be required to implement an ongoing process to manage conflicts of interest. He also suggested that firms should provide investors an “ADV-like document” that provides plain English descriptions of conflicts and fees. Further, he proposed that representatives should either provide similar information in addition to information regarding the risks and benefits of an investment to investors at the time of sale, or in a follow-up communication after a recommendation.
Lastly, while he does not believe that the goal should be to eliminate fee differences across investment products, Ketchum suggested that firms should “take concrete steps to address the incentives for their registered persons from differential product compensation.” According to Ketchum, these efforts could be clearly demonstrated by firms offering consistent compensation levels regardless of the level of payment provided through loads or trailer fees. He suggested that firms could also task compliance with focusing on the sale of expensive products and require a “clear rationale” as to why that particular product was in the customer’s best interest. However, he recommended that smaller firms should be given flexibility to demonstrate that they are acting in the best interests of customers to lessen the compliance burden.