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The SEC’s Best-Interest Proposal: What We Told Regulators

The best-interest proposal could use more specificity

Aron Szapiro 


In April, the Securities and Exchange Commission proposed a rule—“Regulation Best Interest”—that would raise standards of conduct for broker/dealers. The SEC gave industry groups, advocates, and the public an Aug. 7 deadline to submit any comments about the proposal.  

We at Morningstar have turned in our response. In general, we think the rule could be strong enough to maintain momentum toward best-interest advice, as long as the SEC irons out some of the details. 

Ways to improve the SEC proposal  

We support the SEC’s principles-based standard of conduct for broker/dealers to reduce their conflicts of interest and encourage them to act in their clients’ best interests. Nonetheless, we have several suggestions for ways to better define this standard to ensure that broker/dealers adequately mitigate financial conflicts of interest and know what their obligations are under the standard of care.  

At the top of our list, we believe that the SEC’s proposed regulation needs to identify retirement rollovers as specifically requiring a prudent process and documentation to ensure they are in retirement investors’ best interests. Rollovers, particularly from retirement accounts covered by the Employee Retirement Income Security Act of 1974 (ERISA), require additional scrutiny because most financial professionals have an incentive to recommend that clients rollover their assets.  

Further, participants in ERISA-covered retirement accounts often enjoy institutional pricing for investments and higher levels of protections due to ERISA’s strict fiduciary standards. The final SEC regulation should specifically identify broker/dealers responsibilities when recommending a rollover. 

While we support the expansion of disclosures, we believe publicly available information in a standard taxonomy works best because they empower third parties such as fintech firms to analyze and contextualize critical information and amplify a call to action for ordinary investors.  

The SEC is missing a vital opportunity to require more disclosure on key potential conflicts of interest, such as load-sharing and revenue-sharing data. (Even worse, what little data we have on conflicts of interest are being phased out due to changes in mutual fund reporting requirements.) 

What have the trends been on conflicted payments leading up to the SEC’s best-interest proposal? 

Our econometric analysis suggests that harm to investors from a key financial conflict of interest—load-sharing between mutual funds and intermediaries—appears to have declined since 2010. That also happens to be the last year that much of the Department of Labor’s regulatory impact analysis for its “fiduciary rule” was based.  

So what’s led to a reduction in harm from conflicts? It could be due to regulatory pressure, pre-existing trends away from load-sharing, or a mix of the two.  

While it’s hard to draw definitive conclusions without better data, we believe regulatory action has accelerated a move toward business models in which financial advisors put their clients’ interests first.  

Here’s why: Flows into mutual funds paying unusually high excess loads declined after the Labor Department proposed its fiduciary rule in 2015, and this shift was statistically significant.  

This reduction in the distortionary effect of conflicted payments suggests that firms put in place effective policies and procedures to mitigate conflicts of interest in response to the Labor Department rule. Furthermore, the SEC’s proposal could maintain this important momentum if it’s specific in its requirements and those requirements are strong. 

What’s next for the SEC best-interest proposal? 

The SEC is likely to make some changes to their best-interest proposal, and we hope commissioners will add the specifics that we think is necessary. However, the way the rule is written right now, it’s vague enough that it could lead to a range of enforcement actions.  

To that end, the rule could maintain the momentum toward advisors providing advice in the best interests of their customers or it could come up short. But more specificity would help lead to investors getting more consistent, high-quality, impartial financial advice. 

Learn more about how Morningstar helps advisors deliver best-interest advice.

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