InvestmentNews (November 4, 2017) – The new SEC chairman is confident he can come up with a rule better than that of the Department of Labor — one that satisfies brokers, investment advisers and investor advocates alike

In his first month as chairman of the Securities and Exchange Commission, Jay Clayton put the wheels in motion to formulate a uniform fiduciary standard for brokers and investment advisers, something that eluded his two direct predecessors and which supporters and critics alike agree could be a herculean task.

Sworn in on May 4, Mr. Clayton released a request for comment on fiduciary duty on June 1, making it one of his first official actions. And in October, he told lawmakers that the SEC staff was already drafting a fiduciary proposal.

But in taking the fiduciary rule by the horns, Mr. Clayton is grabbing hold of a bull that could wind up goring him. He’ll have to navigate strong passions on both sides of the fiduciary debate, which has roiled the financial advice industry and in the past split the five-member SEC.

Mr. Clayton’s alacrity in addressing fiduciary duty is partly being driven by the Labor Department’s work on its own fiduciary rule, which was partially implemented in June and its enforcement mechanisms are now under a review ordered by President Donald J. Trump. That review could lead to substantial revisions or possibly a repeal.

The Trump administration and industry critics of the fiduciary rule say they want the SEC to take the lead on crafting a rule that would require brokers to act in the best interests of their clients in all investment accounts. The DOL rule applies only to retirement accounts. Supporters of the DOL rule are worried that the SEC will replace it with a weaker fiduciary standard.

More main street

If anyone can reach an agreement on fiduciary duty, Mr. Clayton might be that person. He has a Wall Street pedigree, yet says his priority is representing the interests of the average investor.

Even though as a lawyer at Sullivan & Cromwell he represented some of the biggest Wall Street firms, including Goldman Sachs, UBS and Deutsche Bank, Mr. Clayton told lawmakers at his Senate confirmation hearing in March that his upbringing was more Main Street than Wall Street.

He spoke of his grandfather, Pat Kerwin, “a small-town lawyer and perpetual public servant” in Lykens, Pa., who took the young Mr. Clayton to “township meetings, real estate closings and estate auctions” which left an impression on the future SEC chairman.

Heading the SEC is the first regulatory job Mr. Clayton has held. He has an eclectic educational background that includes engineering and law degrees from the University of Pennsylvania and both a bachelor’s and master’s degree in economics from the University of Cambridge in England.

Mr. Clayton, 50, has been married for 25 years, and his SEC office overlooking the U.S. Capitol is decorated with photos of his three children. His wife, Gretchen, is a vice president at Goldman Sachs.

Though the SEC did not respond to a request to interview Mr. Clayton, in speeches and testimony before Congress, Mr. Clayton has said that the long-term interests of Main Street investors — he refers to them as “Mr. and Ms. 401(k)” — will guide the SEC in everything that it does.

That could bode well for supporters of a strong fiduciary rule.

“If ever there was something sort of singularly important to retail investors, it’s, ‘What’s the duty of care?'” Annette Nazareth, a former SEC commissioner, said at a National Society of Compliance Professionals conference, in October. “In that context, he is going to try to come up with something. I don’t know what they’ll be able to do.”

Mr. Clayton has stressed that a fiduciary rule should preserve investor choice, be clear and easy to understand, apply consistently across investment accounts and be the product of cooperation between the SEC and DOL.

Advocates for the DOL rule worry that Mr. Clayton’s insistence on “preserving choice” will result in a disclosure-based rule that favors the brokerage industry. In the past, brokers have been required to recommend investments that are “suitable” to a client’s needs, but not necessarily to act in their “best interests.” Investment advisers, on the other hand, adhere to the stricter best-interest standard, which is the standard the DOL has adopted for its fiduciary rule.

As he begins his one-year term as president of the Public Investors Arbitration Bar Association, Andrew Stoltmann has made protecting the DOL rule a priority.

“The main concern that many of us have is that [Mr. Clayton] is going to attempt to water down the DOL fiduciary rule,” Mr. Stoltmann said. “A disclosure-based fiduciary duty rule is useless in terms of protecting investors. My fear is that’s what will come out of the SEC in the next 12 months.”

Barbara Roper, director of investor protection at the Consumer Federation of America, agrees. “If the talk about Mr. and Ms. 401(k) doesn’t translate into policies that reflect the reality of their situation, then we’re not going to have any common ground,” she said.

Two standards

Critics of the DOL rule welcome Mr. Clayton’s arrival on the scene. One of their concerns is that under the current DOL rule there are two standards: one for retirement advice and the other for all other types of investment advice.

Andrea McGrew, chief compliance officer at USA Financial, said that while she “likes the idea” of the DOL rule, there should not be one standard for retirement advice and a different standard for all other accounts. “That’s really difficult for an operations team to monitor,” she said.

“[Mr. Clayton] has a little bit better understanding of how the investing process within a firm works,” she said. “I’m hoping that having that knowledge helps him put in place effective yet realistic regulations.”

Marc Lowlicht, chief executive of Opes Private Wealth Management, also is concerned about the rule only affecting some accounts.

“If the SEC’s involved in the fiduciary rule, it will become consistent across the different firms on how financial advice is delivered to individual investors,” he said.

David Tittsworth, counsel at the law firm Ropes & Gray and former president of the Investment Advisers Association, believes Mr. Clayton will maintain an independent approach to the fiduciary issue.

“He’s not going to be a shill for investment advisers or broker-dealers or other regulated entities,” Mr. Tittsworth said.

The middle ground

Robert Plaze, a partner at the law firm Proskauer and former deputy director of the SEC Division of Investment Management, also expects Mr. Clayton to try to maintain the middle ground.

“He is going to attempt to bring some sort of consensus,” Mr. Plaze said. “This issue will be very difficult to create a consensus.”

Mr. Clayton’s predecessors have failed to achieve that consensus. The SEC has wrestled with the issue of a uniform fiduciary standard for more than 20 years.

Former SEC Chairwoman Mary Schapiro advocated for a fiduciary standard, which was a recommendation contained in a Treasury Department report on regulation issued at the beginning of the Obama administration in 2009.

That Treasury report helped catalyze a provision of the Dodd-Frank financial reform law that gave the SEC the authority to promulgate a fiduciary duty rule after first studying the issue, and which is still the issue.

A staff report in January 2011 recommended that the SEC propose a fiduciary rule. But the two Republican commissioners at the time, Kathleen Casey and Troy Paredes, wrote a sharp dissent on the study. They asserted that the staff had not provided a cost-benefit analysis that justified a rule. In addition, Republicans on Capitol Hill expressed opposition to a fiduciary rule.

Ms. Schapiro finally gave up and never brought an investment-advice regulation to a vote during her tenure. She believed that she needed a 5-0 vote among commissioners to withstand a court challenge that was sure to come following adoption.

Mary Jo White took over as SEC chair in April 2013. She spent two years studying the fiduciary issue. In March 2015, she announced that she was in favor of a rule. The next month, the DOL proposed its own rule.

Unable to find votes

But Ms. White never brought a proposal up for commission action because she wasn’t able to find at least three votes. The political fissure first illustrated by Ms. Casey’s and Mr. Paredes’ dissent on the 2011 study continued, as other Republican commissioners adopted their opposition to a fiduciary rule.

In order to make history on fiduciary duty, Mr. Clayton will have to please both sides of the debate, a monumental task. As a practical matter, he must also deal with an SEC currently short two members, although a confirmation process to fill the vacancies is already under- way.

A fiduciary rule that is based on disclosure would please industry opponents of the DOL rule and likely lead to a lawsuit from investor advocates. Conversely, if the SEC rule hews too closely to the investor-protection requirements of the DOL rule, it will likely produce an industry lawsuit.

“The hard thing isn’t designing a rule that makes sense and could work,” Ms. Roper said. “The hard thing is designing a rule that could get three votes and that can withstand a legal challenge.”

The brokerage industry has placed its hopes in him, but Mr. Clayton has said he is keeping an open mind about a potential fiduciary rule, an approach that could help him build relationships with investor advocates.

“We have a lot of comments to work our way through, a lot of perspectives,” he told reporters on the sidelines of the Securities Industry and Financial Markets Association annual conference in Washington in October.

For their part, investor advocates are frustrated with the uncertainty that has surrounded advice standards for almost two decades, and especially since the DOL first proposed a rule in 2010, said John Anderson, managing director of the SEI Advisor Network.

“It’s about an exhaustion level,” Mr. Anderson said. “The conversation around the SEC is ‘I’ll believe it when I see it’ when it comes to the fiduciary rule.”