Expansive Government Regulation of Brokerage Accounts Harms Nest Eggs

The North American Securities Administrators Association (NASAA) and the Department of Labor (DOL) are simultaneously issuing changes to rules that would increase costs and consequently lower returns for retirees and individual investors. In combination these amendments would comprehensively alter the market structure for providing cost-effective brokerage account investment options for the $33 trillion U.S. retirement market.

NASAA, which “represents state and provincial securities regulators in the United States, Canada and Mexico,” is proposing changes to its broker-dealer Business Practices Rule. The proposed rule significantly diverts from the principles of the Securities and Exchange Commission’s (SEC) Regulation Best Interest (Reg BI). The amendments would wrongly apply traditionally fiduciary requirements, which are normally applied to registered investment advisers (RIAs), to broker-dealers.

RIAs and broker-dealers provide fundamentally different services. Broker-dealers buy and sell securities for their customers and themselves. RIAs offer advice to their customers and are strictly obligated to comply with their fiduciary duties of loyalty and care. Broker-dealers are paid a commission conducting securities transactions, while RIAs are paid a fee for providing advice or managing assets.

Under the proposed rule, if a broker-dealer places “the financial or other interest of the broker-dealer or agent ahead of the interest of the retail customer” or “recommend[s] an investment strategy or the sale or purchase of any security without a reasonable basis to believe that the recommendation is in the best interest of the retail customer” then the broker-dealer could be found liable for dishonest or unethical business practices. The amendments also state that these new obligations cannot be “satisfied through disclosure alone,” but fails to explicate about how else broker-dealers may convey that they are following the rules. Without any substantive justification, NASAA is arbitrarily amending these rules in a way that conflicts with federal law and introduces prohibitively expensive reporting requirements for broker-dealers. These new mandates will ultimately pass cost increases down to investors in the form higher fees, fewer services, or lower returns. 

The proposed rule will also strictly regulate how broker-dealers can pay for their services and operations. The rule automatically assumes that a broker-dealer has placed its financial interest ahead of an individual investor if it partakes in:

(i) sales contests; (ii) sales quotas; (iii) bonuses; or (iv) any other non-cash compensation that are based on the sales of specific securities or specific types of securities within a limited period of time, or rewards the broker-dealer or agent with additional cash or non-cash compensation beyond the sales commission as the result of that recommendation.

Broker-dealers should comply with Reg BI and act in the best interest of individual investors and retirees while eliminating conflicts of interest. However, the proposed amendments to the Business Practices Rule go beyond Reg BI and would significantly increase costs for broker-dealers by altering the structure for collecting fees, and consequently raise costs for retirement plans and funds offered to individual investors through brokerage accounts. If the proposed rule is adopted, all forms of broker-dealer compensation, except for commissions, would likely be illegal. 

In September 2023, the Massachusetts Supreme Judicial Court issued a ruling that would compel broker-dealers registered in Massachusetts to comply with Reg BI and state fiduciary laws. The Massachusetts ruling in combination with NASAA’s proposed rule would lead to a “patchwork of inconsistent state-level standards.” According to a statement made by former SEC chairman Jay Clayton, this patchwork “will increase costs, limit choice for retail investors and make oversight and enforcement more difficult.” This would be in direct contravention to the goals of nationwide policy uniformity as enacted in the National Securities Markets Improvement Act of 1996 (NSMIA). If a state were to adopt NASAA’s proposed rule, it would likely be found as “an obstacle to the accomplishment and execution of the full purposes and objectives of Congress” because of its conflict with NSMIA.

At the federal level, DOL issued a proposed rule that would apply unnecessarily stringent, ambiguous, and costly fiduciary standards to market participants offering investment advice under the Employee Retirement Income Security Act of 1974. This rule is a successor to the Fiduciary Rule issued under the Obama administration. In 2018, the Obama rule was negated by the U.S. Court of Appeals for the Fifth Circuit. There is a “difference between a fiduciary’s offering regular investment advice for a fee and ordinary brokerage transactions.” If the Fiduciary Rule remained viable, it “was likely to produce only modest benefits and posed substantial risk to investor welfare.”

Under current law in order to be considered a fiduciary, a person must meet these five requirements:

(1) they render advice as to the value of securities or other property, or make recommendations as to the advisability of investing in, purchasing, or selling securities or other property, (2) on a regular basis (3) pursuant to a mutual agreement, arrangement, or understanding with the plan or a plan fiduciary that (4) the advice will serve as a primary basis for investment decisions with respect to plan assets, and that (5) the advice will be individualized based on the particular needs of the plan.

The proposed rule would scrap this five-pronged test and adopt requirements that encapsulate all forms of investment advice. The proposed rule creates a lot of uncertainty without offering a substantive economic analysis. Moreover, the proposed rule’s “lack of exclusions or safe harbors creates significant uncertainty regarding which activities clearly fall outside” its scope.

The proposed rule mentions twenty-one times about how it “does not have data” on topics such as how many individual retirement accounts are opened each year, and how many small financial institutions would have to make additional disclosures for the pooled 401k plans they service, among other relevant facts. The proposed rule should not have been issued prior to collecting and analyzing this data. This incomplete analysis of the benefits versus the costs defies the notice and comment process as outlined in the Administrative Procedure Act and could be found to be arbitrary and capricious.

NASAA and DOL are concurrently imposing more stringent regulations on broker-dealers operating in the U.S. without any sufficient cost-benefit analysis to substantiate the claims that the amendments would mitigate conflicts of interest or financially benefit individual investors and retirees. Instead, the proposed rules will undermine brokerage investments and significantly hamper returns to investors and retirees. The proposals should be withdrawn for the detrimental effects they will impose on U.S. investors and retirees, and for their defiance of current laws and regulations already on the books.