Prominent liberal lawmakers balked when President Obama nominated Gary Gensler to helm the Commodity Futures Trading Commission in the midst of the financial and regulatory catastrophe of 2008-2009. The move led Sen. Elizabeth Warren, a Massachusetts Democrat, to allege that the confirmation of the former Goldman Sachs partner would essentially allow Wall Street to regulate itself.
Journalists at left-of-center ProPublica were quick to point out that as the former assistant Treasury secretary for Bill Clinton, Genlser actually worked to prevent the Securities and Exchange Commission and the CFTC from regulating the very credit swaps and other mortgage-backed securities whose failures were catapulting the market into a generational meltdown.
There were justifiable reasons to give pro-regulatory lawmakers pause about his nomination. But Gensler was confirmed and went on to prove his critics wrong. In fact, in the words of former Democratic congressman Barney Frank, “Gensler was the toughest regulator under Obama.”
Flash-forward 13 years to now, and the former Wall Street banker has won over one of his toughest critics. “He is a tenacious regulator who stood up to the industry titans to rein in their risky behavior,” Sen. Warren tweeted when President Biden nominated Gensler to lead the SEC in January.
Most previous SEC chairs have been securities attorneys with clients on Wall Street. But Gensler, who became a Goldman Sachs partner at the tender age of 30, has extensive experience on both the trading and investment banking sides of the business. Observers think this gives him a deeper understanding of the dynamics of the industry.
When Regulations And Technology Clash
One serious critique of his predecessors is that regulators have failed to keep pace with rapid changes in technology that are altering the business. After leaving the CFTC, Gensler became a professor at MIT’s Sloan School of Management, where he taught a class in blockchain and cryptocurrencies. Though he is something of an expert in this area, he recently told Sen. Warren that he lacked the broad authority to strengthen investor protection over this nascent market after she voiced concerns about its potential to harm consumers. At the same time, he also indicated that he shared some of her concerns and asked her to help in expanding his bailiwick.
The sea change brought about by Gensler’s SEC confirmation is still reverberating throughout the securities industry, which is bracing for a heavier enforcement hand. “We anticipate that the SEC is really going to leverage Regulation Best Interest and existing interpretation through compliance and enforcement rather than redo it,” says Karen L. Barr, the president and CEO of the Investment Adviser Association, in an interview with Financial Advisor.
“We expect a heavy examination focus on fiduciary duty and Form CRS,” Barr says of the customer relationship summary that explains an advisor’s offerings and business activity. “We’re already seeing it. The SEC issued a bevy of enforcement cases [in July] around firms that didn’t file Form CRS. It was kind of a no-brainer. After they do the low-hanging fruit, they’ll go after the substance of disclosures.”
Gensler, who was known to implement Dodd-Frank requirements much quicker than his peers at other regulatory agencies, is taking the same tack at the SEC with Reg BI, the agency’s landmark retail investment advice rule.
In its first major Reg BI enforcement action, the SEC charged 27 firms for failing to file and deliver the customer relationship summaries to retail investors. The form is supposed to spell out the services a financial professional or broker-dealer provides, how they charge customers, their conflicts of interest and whether they offer fiduciary-level advice. The firms—some 21 investment advisors and six broker-dealers—agreed to settle SEC charges for fines ranging from $10,000 to $97,523.
The cases “reinforce the importance of meeting regulatory obligations and providing retail investors with information that is intended to help them understand their relationships with their securities industry professionals,” said Gurbir S. Grewal, the director of the SEC’s Enforcement Division, in a statement.
Getting Tough With Reg BI
The SEC’s more aggressive work recently on Reg BI enforcement is not expected to be an isolated event. “You can really see this in the SEC risk alert on wrap fee programs really focusing on examining whether firms are making decisions about wrap fee accounts that are in clients’ best interest and whether they’re really monitoring the trading in those accounts,” Barr says. “To me that’s an example of what the SEC will do around Reg BI. They are really examining closely to see that RIAs and broker-dealers are backing up their actions through compliance and disclosure.”
Aron Szapiro, head of policy research at Morningstar, says he expects the SEC to use “regulation by enforcement” and zero in on how advisors and broker-dealers choose reasonably available investment alternatives. Szapiro also thinks the way firms choose to reduce their conflicts of interest and disclose remaining conflicts will top the agency’s Reg BI compliance and enforcement priorities.
“There are such a wide variety of approaches firms are taking with this principles-based regulation,” he says. “I think you’ll see some SEC enforcement and some regulatory guidance to mitigate” outliers and noncompliance.
According to Robin Traxler, the senior vice president of policy and the deputy general counsel of the Financial Services Institute: “We’re hearing from our members that the implementation of Reg BI has gone well. We’ve also heard that members are having really helpful conversations with the SEC and [the Financial Industry Regulatory Authority] exam staff, specifically when the staff expresses concerns or has questions about the way a person implemented Reg BI.”
However, Traxler adds, “If the SEC interpretations of Reg BI evolve over time as they go through their examination process, we would expect them to provide appropriate guidance or exam findings reports to the industry as opposed to widespread enforcement actions. So far, we’re encouraged by what we’ve seen in the common exam findings that the SEC has issued. But we will continue to monitor developments in examinations.”
As for the slew of Form CRS settlements, Traxler says, “It was not a surprise. Form CRS has very clear requirements, and the firms just didn’t file. So I think that is us seeing the SEC at work and ensuring that Reg BI is being implemented properly and reaching its intended goals.”
One of the greatest dislikes of an advisory firm is duplicative regulatory exams, where Finra and SEC examiners show up at the same time or back to back and fail to coordinate their work. That has been a particular concern with regard to exams of firms’ implementation of Reg BI. After all, it was a recurrent issue during the Obama and Trump administrations. But Traxler said she hasn’t heard any firms complain about it so far.
Under SEC oversight, Finra is also cracking down on rogue brokers by forcing the firms that hire them to set aside financial reserves to pay arbitration awards they have been known to escape by closing up shop and reopening under new names. The new rule was approved by the SEC in early August.
The crackdown on recidivist brokers is not an issue for FSI members, Traxler says. “We’ve historically taken the position that advisors who do bad things and have violated rules should not be allowed in the industry.”
On a bright note, state securities regulators may have listened to FSI and industry requests to allow Reg BI to take effect before they created their own state-by-state patchwork of varying best interest regulations. The North American Securities Administrators Association (NASAA) just sent a Reg BI survey to all its regulated firms and professionals to assess how the rule is working, says Traxler, who adds, “We hope they give Reg BI an opportunity to work.”
The DOL Is Back
While the industry watches the SEC, some of the toughest challenges for advisors and broker-dealers are coming out of the Department of Labor, which is overseen by a politician who was never a regulator—the newly minted U.S. labor secretary and former two-term Boston mayor Martin J. Walsh.
The DOL’s bench will get deeper if Biden’s nomination to head the DOL’s Employee Benefits Security Administration, Lisa Gomez, is confirmed. She has extensive experience as an attorney working with retirement plans and ERISA, which would help the Labor Department enforce its rules and create new ones, which it has promised to do.
The DOL challenge for advisor firms, broker-dealers and insurance brokers is the agency’s approval of the Trump-era fiduciary rule, which expands the fiduciary duty for advisors handling retirement plans and IRA rollovers. These transactions have historically been treated as a onetime, nonfiduciary service. The rule took effect February 16, but the Treasury and the IRS are deferring compliance with the new rules until December 20 as long as “impartial conduct standards” are met.
“Much to the surprise of almost everyone, the Biden administration allowed it to become a final rule,” says Fred Reish, a partner at Faegre Drinker and one of the most renowned fiduciary experts in the country. “Then the DOL regulatory agenda was released in July and there was an agenda item that said they will revisit the fiduciary regulation and issue new proposals in December of this year.”
The new rule, called “Prohibited Transaction Exemption 2020-02, Improving Investment Advice for Workers & Retirees,” says that if a financial professional makes a rollover recommendation from which he or she is going to benefit, the professional can only achieve an exemption from fiduciary duty if certain conditions are satisfied.
“Some of the exemptions are burdensome and they even apply when an advisor recommends that an investor roll over one IRA into another,” says Reish, who is working with advisory firms, broker-dealers and insurers to help them be compliant by December 21, when the DOL’s nonenforcement field bulletin expires and the agency can start cracking down on alleged violations.
The fact that a rollover from an IRA to another IRA is now a fiduciary recommendation in and of itself “will be a shock to many firms,” Reish says.
“I would suspect that every firm does IRA to IRA rollovers, but this has not been well publicized,” he says. “The recommendation is now a fiduciary recommendation, which requires an analysis of the IRA as it currently exists versus costs and investments and services you will provide with the rollover. IRA holders also need to receive a statement detailing why the rollover is in the holder’s best interest.”
Firms need “policies and procedures to mitigate conflicts of interest, which is not a familiar concept for broker-dealers and insurers,” Reish says. “Each year, firms also need to create and file a retrospective review of how [they] met the requirements, which has to be signed by a firm executive. How will firms with two or three advisors be able to meet this requirement?
“My concern is that many smaller and midsize investment advisor and broker-dealer firms don’t realize that this rule will apply to them. Even if they start today, it would be a rush to get into compliance by December 21.”
Some of the smaller RIA firms are developing an education-only approach, where they don’t make recommendations and try to sidestep the fiduciary requirement, Reish says. If an investor decides to open up an IRA with the firm, some financial professionals may believe they can then offer investment recommendations via the already-existing IRA without triggering the rollover prohibited transaction exemption, but that remains to be seen, he adds.
The Insured Retirement Institute (IRI) and FSI are currently in talks to consider asking the DOL for an extension of the nonenforcement bulletin past December 21. That would give their members more time to meet the requirements.
“Our members are working diligently to implement the [prohibited transaction exemption], but we do understand from them the time line is tight,” says FSI’s Traxler. “I think if the correct coordination and communication takes place and firms are given time to accurately implement the PTE, there is no reason to believe investors will not be well served.”
Most of FSI’s members are dually registered, so they can provide fiduciary advice. They just need time to properly implement system, compliance and education training for a brand-new rule that just passed in February, Traxler says.
“We’re four and half months out from the deadline,” says Jason Berkowitz, the chief legal and regulatory affairs officer at the Insured Retirement Institute, which represents both insurers and broker-dealers that offer annuities. “There is a ton of work that needs to be done and some need for consideration if an extension may be needed or appropriate. We are exploring that right now. We haven’t made the decision. We are still in the fact-gathering stage,” he says.
He hopes an extension could be broached with the DOL through “friendly conversation.” “I think what we are seeing is that despite everyone’s best efforts, there are still some significant challenges regarding folks trying to make sure that they have some clarity around when they can make recommendations,” Berkowitz adds.
For fiduciaries, the DOL rule “was really nothing new,” says the Investment Adviser Association’s Barr. “They have been using these principles for the last 80-plus years. They’re very comfortable with the interpretation of what their duties are. What might be a new step for them is the documentation that is likely to be expected by examiners to document their steps behind making recommendations.”
Really smart firms will use the fiduciary rule to show value, adds Morningstar’s Szapiro. “They’ll use it to say, ‘Here’s why you want to work with us.’ You can’t just say, ‘We offer more asset classes.’ You have to be able to show through analysis that you are offering better advice or better services that are able to meet individual investor goals.”