Anger over the Securities and Exchange Commission’s proposed Regulation Best Interest bubbled over during a recent one-day event for registered investment advisors, with some professionals even calling for SEC Chairman Jay Clayton to step down because of  what they say is his willingness to prop up broker-dealer industry at investors’ expense. 

The vitriol bubbled over during a seminar sponsored by the Institute for the Fiduciary Standard in Philadelphia last week, where a cadre of veteran industry professionals and attorneys said that a lawsuit to stop the SEC’s proposal is virtually guaranteed if it is passed allowing brokers to broadly offer advice without registering as fiduciary advisors.

Speaker after speaker at the event found fault with the SEC’s controversial Reg BI proposal, which was meant to ease investor confusion and harmonize regulations between brokers and advisors. Critics at the seminar maintained the proposal appears instead to overstep the SEC’s legal authority, which does not extend to granting brokers’ “advisory” status with a preferential carveout; from required fiduciary regulation. The Financial Planning Association successfully sued the SEC over its last attempt to provide brokers with a carveout from fiduciary requirements in 2007.

“The speakers’ message was one of alarm,” said Knut Rostad, co-founder and president of the Institute for the Fiduciary. “The SEC’s disdain for investor protection and loyalty to broker protection-- even openly worrying in the proposal that eliminating conflicts harms brokers--hits a raw nerve. RIA leaders will oppose it any way possible.”

The belief among some RIAs is the SEC and SEC Chairman Clayton are using the proposal to help shore up the broker-dealer declining commission-based business at the expense of investor protection and already-effective advisor regulation.

Ron Rhoades, a professor at Western Kentucky University and former advisor who has been instrumental in the creation of industry ethics, called the SEC’s Reg BI “a vast conspiracy theory.” The proposal was orchestrated by the broker-dealer industry and their self-regulator FINRA, said Rhoades. “The three of them pushed it on the SEC and because we have a very weak SEC Chairman in Jay Clayton, who adopted the BD industry’s platform.”

“Broker dealers know their market-share has been continuously declining and the SEC wants to prop up broker-dealers by letting them pretend that they act in the best interests of their clients. And there is nothing in this [proposed] regulation that requires that,” said Rhoades. “So basically it’s the SEC aiding and abetting a massive fraud called Reg BI.”

When asked how Clayton could fix the proposal, Rhoades said it wasn’t fixable and that Clayton should step down. Others echoed that sentiment.

“When the SEC says we’re preserving investor choices, what they really mean is they’re propping up captive brokers and wirehouse firms,” said Brian Hamburger, founding and managing member of the Hamburger Law Firm. “When the SEC says harmonization, what they really mean is equalization and creating false consumer safeguards and destroying distinctions within our financial ecosystem that really makes it great and something the world admires,” said Hamburger, also the co-founder of MarketCounsel, a regulatory compliance consulting firm for entrepreneurial investment advisors.

Hamburger said he met with SEC officials recently and walked away wondering why regulators would want to undermine historically sound investor protections that exist in advisor regulation? “It doesn’t make sense. What the SEC has in fact done, when you look at these proposals in conjunction with one another, is effectively kill the fiduciary standard,” Hamburger said. “They do that in a really smart way, because what they do is extrapolate the two most important words from the fiduciary standard--and we all know that those words are best interests--and graft them onto a suitability standard. So, it’s not enough that we codify the suitability standard, but we’re eroding what’s so precious about the fiduciary standard.

Hamburger and other attorneys said they have no doubt that the SEC will be sued if it pushed forward with Reg BI as is.

Advisors’ anger may not be entirely misplaced.  In current law, fiduciary advisors are required to put their clients “best interests” before their own, while brokers can offer products that are merely suitable.  Now, the SEC’s proposal uses the same “best interest” term for brokers without extending the fiduciary standard of care to the brokerage profession, critics say.

By law, brokers are only allowed to offer “incidental” advice without “special” compensation such as fees.

But it appears that someone forgot to tell the SEC that.  The Reg BI proposal repeatedly characterizes the broker-dealer model as a “model for advice” and calls it a “pay as you go’” model for advice. In the proposal the SEC also suggests that preserving the broker-dealer model is about “preserving investor choice across products and advice models” and advocating for “continuing existence of the broker-dealer model as an option for retail customers seeking investment advice.”

SEC Chairman Clayton continues to defend the proposals, with investors, the industry and lawmakers. “Retail investors expect high-quality advice where their investment professional is not placing their interest ahead of the investor’s interest.” Clayton said recently. “I want to make sure they are getting the protections they expect.”

Investors themselves have told SEC Chairman Clayton in recent months during seven roundtables that they are unable to use the SEC’s Reg BI or its “relationship summary” to discern the legal standard of care they should expect or what they’ll be charged. The form is ostensibly supposed to lay bear brokers’ costly conflicts of interest. Those conflicts—such as more expensive commissions, sale charges and a limited selection of under-performing products that pay the BD more for platform space, cost investors some $18 billion annually, according to the GAO. One investor, a 70-year old retiree in Baltimore, asked SEC Chairman Clayton point blank why he doesn’t just make brokers fiduciaries “since that’s what investors think.”

But investors have no idea the depth and breadth of conflict they’re paying for, said one former high-level broker who left behind a lucrative commission-based sales practices at Merrill Lynch in 2011 to create a fee-only fiduciary firm.

Paul Pagnato, the founder and partner of PagnatoKarp, a fee-only firm, recounted the numerous ways that investors are ripped off by what he said are hidden and costly brokerage industry conflicts of interest, which the SEC proposal does not prohibit.

Pagnato spent three years interviewing experts, regulators and SEC officials about what a fiduciary practice should look like, in order to strip out virtually all conflicts from his new firm’s practices, which has grown from $900,000 to nearly $4 billion in advisable assets in seven years.

Pagnato said he took a 35% pay cut when he left broker-dealer, a financial hit that comes from stripping out conflicts brokerage clients pay unwittingly. “Where did that 35% come from? It’s from the deferred sales charges, commissions, IPOs, secondary offerings, 401(k) plans, deferred compensation plans, mutual fund trails that broker-dealers charge,” Pagnato said.

“The role that limited choice plays at broker dealers was also a staggering for me,” he added. “At a broker dealer you are captive to their platform, their investments, their lending, their product creation and your clients’ assets are custodied there. So as an example, your clients’ cash goes into their money market, and it may be playing 25 basis points at a broker dealer, when elsewhere they can earn 2%. Now we are able to find the very best, profitable and cost-effective options for our clients,” Pagnato said. “But before, like so many brokers, we didn’t know what we didn’t know.”

Jamie McLaughlin, a veteran industry consultant, said that in two of the four large broker-dealers he works with “think they’re fiduciaries. They believe they’re conducting business in the best interest of clients and are fully transparent,” said McLaughlin, who added that some times brokers don’t understand how conflicted their selling agreements are or realize their compensation is embedded in sometimes supporting the house, particularly on the bond side where they’re selling BD syndicated products, he added.

Advice will remain profitable, even as products and distribution lose their pricing power in the next market cycle—a fact not lost on broker-dealers who have actively lobbied for the registration carveout SEC proposal would give them, McLaughlin said.