Imposing a best interest standard on U.S. brokers is the way to go, but proposals put forth earlier this year by the U.S. Department of Labor are not the way to do it, says Richard Ketchum, chairman and CEO of U.S. self-regulatory organization (SRO), the Financial Industry Regulatory Authority (FINRA).
In fact, implementing a best interest standard for broker-dealers that is created under securities laws “is the direction we must go” for both investor protection reasons and industry culture reasons, Ketchum said at FINRA’s annual conference in Washington, D.C., on Wednesday.
“A best interest standard tailored for broker-dealers aligns the needs of the investor with the goals of the securities firm. It protects investors by providing a more consistent set of obligations across securities advice providers. And it supports the direction of many broker-dealers today,” he said, adding that it should build on existing broker-dealer regulation.
Indeed, Ketchum argued against a proposal put forward by the U.S. Labor Department earlier this year that would expand the fiduciary definition to capture brokers providing retail investors with retirement advice. “I believe moving to a properly designed best interests standard is a must,” he said, but he added that the current Labor Department proposal “is not the appropriate way to meet that goal,” citing practical concerns with its proposal in a number of areas.
Instead, the U.S. Securities and Exchange Commission (SEC) should be setting the standard in this area, he said. In fact, Ketchum outlined his recommendations for crafting a best interest standard, including the disclosure it should require, and a recommended approach to managing conflicts.
A best interests standard is needed, Ketchum said, because FINRA’s compliance examinations and enforcement dockets “continue to reveal unacceptable instances of unsuitable sales of more complex products without the appropriate disclosure to clients of the downside risks and fees associated with the products.”
In addition, he notes that some firms are not properly managing conflicts of interest and that there continues to be investor confusion about the differing standards for broker-dealers and investment advisors in the U.S.
“I continue to believe that the clarity of a ‘best interest of the customer’ standard would be an important step forward in encouraging firm compliance cultures that translate to consistent actions to place the interests of the customer first,” he said.
In addition to sketching out considerations for a best interests standard, Ketchum also suggested that “firms should take concrete steps to address the incentives for their registered persons from differential product compensation. One way firms might address this issue would be to follow what has become a growing best practice of creating fee neutrality across products that minimize incentives for salespersons to favour one type of product over another.”
Instead of trying to level fees completely, or in addition to targeted fee levelling, Ketchum also said that firms could “create targeted compliance oversight that specifically focuses on the sale of more expensive products and demands a clear rationale as to why it was in the best interests of the customers.
“It is time for us to reach agreement on a best interest solution that embraces three essential 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,” he said. “It is the right time to move forward.”
In response to Ketchum’s remarks, Kenneth E. Bentsen Jr., CEO of U.S. investment industry trade group the Securities Industry and Financial Markets Association (SIFMA), echoed the group’s opposition to the Labor Department proposals and noted that Ketchum, “articulated key elements that are important to ensure that customers’ interests do indeed come first — through identification and management of conflicts, targeted fee and product risk disclosure and effective management of compensation incentives to registered persons.
“SIFMA believes the Department of Labor’s proposal imposes conditions and obligations far beyond what a best interest standard requires, the result of which will limit investor choice and increase investor costs, unnecessarily so in our opinion,” Bentsen Jr. said. “Equally troubling is that this [Department of Labor] proposal underscores a failure in the public policy making process. Rather than adopting a policy prerogative that will apply across the entire retail marketplace, we are headed in a direction of bifurcated rules, with compliance and disclosure regimes imposed on the same market participants and investors from different regulators. It seems illogical that we cannot address this in a uniform manner on behalf of the investing public.”