Advisor Services

To expand the menu panel use the down arrow key. Use Tab to navigate through submenu items.

Midterms in sight: Regulatory action and partisan gridlock

Member for

1 year 2 months
A104398
Submitted by Brian.Lavelle on Wed, 06/13/2018 - 10:37
RIA Washington Watch

RIA Washington Watch is an ongoing series featuring the observations, insights, and analysis of Michael Townsend, vice president of legislative and regulatory affairs for Charles Schwab & Co., Inc., regarding issues and topics that affect Registered Investment Advisors (RIAs), their clients, and the RIA industry.

Michael Townsend

DOL rule: Court voids the Department of Labor fiduciary rule, delivering a potentially fatal setback, but the SEC takes up the cause.
Budget deal: Congress passes a temporary spending measure, but a government shutdown is still possible just weeks before the midterms.
Vying for majority: Republicans and Democrats square off in what should be a hard battle for the majority in both chambers. 

Sometimes it can seem as though the barrage of headline-making news out of Washington never stops. Personnel changes at the White House, trade disputes, historic developments in North Korea, and the dark cloud of special counsel Robert Mueller’s investigation are all just part of the daily whirl in the nation’s capital. Below the major headlines, however, are a few issues that advisors should keep their eyes on. 

Courts deliver a shocker

The most notable (and least anticipated) development in recent weeks was the invalidation of the Department of Labor (DOL) fiduciary rule by the courts. The first part of the rule, which redefined who is a fiduciary and cracked down on conflicts of interest in the retirement savings space, took effect in June 2017. The second part, which was supposed to take effect January 1, would have required advisors to enter into a Best Interest Contract Exemption with savers. But the Trump administration delayed the proposal for 18 months. On March 15, the United States Court of Appeals for the Fifth Circuit threw out the entire rule. The court concluded that the DOL’s new definition of fiduciary was inconsistent with current law and that the department had exceeded its authority. The court determined that the rule created a new private right of action that Congress had not authorized. A trio of state attorneys general appealed the decision, but the courts have thus far rebuffed those efforts. A Supreme Court challenge is still a possibility, but many legal observers consider the effort a long shot. 

Confusion sets in

Having embraced their fiduciary status last June to comply with the new rule, firms are now relying on rules that no longer exist. In response to the court’s decision, the DOL announced in May that it would not pursue enforcement actions against “investment advice fiduciaries who are working diligently and in good faith to comply with the impartial conduct standards for transactions.” Expect additional guidance from the DOL this year that clarifies how firms should act.

The SEC joins the debate

In April, the Securities and Exchange Commission (SEC) plunged into the debate, proposing two new rules that attempt to clarify the standard of care for broker-dealers and investment advisors. 

The key elements of the SEC’s proposal are as follows:

  • Regulation Best Interest – The agency proposed a new rule requiring broker-dealers to act in the best interest of retail customers when making recommendations. Broker-dealers would need to disclose and mitigate or eliminate conflicts of interest. Unlike the DOL rule, which applied only to retirement accounts, the SEC proposal applies to both taxable and nontaxable accounts. 
  • Relationship Summary Form – Investment advisors and broker-dealers would be required to provide retail investors with a document of no more than four pages that highlights the services being offered, the legal standards of conduct that apply, fees, and conflicts of interest. Additionally, broker-dealers would not be allowed to use “adviser” or “advisor” as part of their title—a change that would help customers more easily distinguish broker-dealers from investment advisors.
  • Investment Advisor Interpretation – The SEC’s proposed interpretation reaffirms and clarifies existing fiduciary duties that investment advisors owe to their clients. Unlike broker-dealers, advisors have a duty to monitor all personalized advice to ensure that the advice continues to be in the client’s best interest.  With respect to conflicts of interest, advisors would need to consider the interpretation’s statement that disclosure alone is not always sufficient. The SEC also requested comments on whether it should propose new rules for advisors including continuing education requirements, mandatory account statements, and financial responsibility obligations (like net capital or fidelity bonding).

A 90-day comment period on the 1,000-page proposal has begun, with comments due to the SEC by August 7. At that point, the SEC will review the comments and potentially revise the proposed rule. Then the five commissioners will meet in an open session to vote on the final rule. Although there is no set timeline for how long the rulemaking process should take, major rule proposals usually require 12–18 months. So it seems unlikely the rule will be finalized before the end of the year. 

Future of the SEC rule remains murky

SEC commissioners voted 4–1 to propose the rule, with only Commissioner Kara Stein, who favors a stronger approach, in opposition. But Commissioners Robert Jackson, Hester Peirce, and Mike Piwowar expressed significant concerns about the proposal for different reasons. All the commissioners supported putting the proposal out for public comment, but none have committed to voting for a final rule. Complicating the political calculus even further, Commissioner Piwowar announced that he will step down in early July. That could result in an extended deadlock between the two Democrats and the two Republicans remaining, or a new commissioner with an unknown perspective on the issue could enter the office before the final rule is considered. Either way, it adds another element of uncertainty about how things will unfold at the SEC in the months ahead.

Bottom line: Pay close attention to this major rule proposal because the outcome is far from certain.

Light schedule on Capitol Hill

With a March budget agreement funding government operations through September 30, Congress is now working on appropriations bills to fund operations for the next fiscal year, which begins October 1. Although a government shutdown this fall is possible, we think it is unlikely just weeks before Election Day. Expect a short-term agreement to keep the government operating through the election. Congress also suspended the debt ceiling until March 2019, meaning the new Congress will have to address that issue next year. 

Congress now faces few deadlines, and looming midterm elections have left little enthusiasm for bipartisanship. As a result, expect few major pieces of legislation to move forward in the months ahead, especially in the narrowly-divided Senate. However, we are watching a bipartisan retirement savings bill that could pick up momentum this summer. The package includes changes that would make it easier for small businesses to band together to offer savings opportunities to their employees and that would allow individuals over 70 to continue to contribute to their IRAs. The bill also calls for lifetime income disclosure to help savers track how their savings will translate to a monthly income in retirement. Despite bipartisan support, this bill may struggle to gain traction because neither party wants to offer a victory to the other in the weeks leading up to the midterm elections.

Tax law settles in

The new tax law, approved at the end of last year, is now in effect, and the IRS continues to work on guidance to clarify it. Not surprisingly, there is a growing effort in Washington to revisit and adjust the new law. For example, Schwab has been working on behalf of advisors to get decision-makers to reconsider two onerous elements of the new law: (1) the repeal of investment advisory expense deductions and (2) changes to the taxation of so-called “pass through” businesses, which have kept some advisories from claiming lower tax rates. Repairs to both issues have gained support on Capitol Hill, but, realistically, there is little hope for revisiting the new law so soon after it has gone into effect. 

House and Senate up for grabs in November

With less than five months to go until Election Day, Republicans and Democrats are gearing up for an intense battle for control of Congress. Historically, midterm elections have been painful for the incumbent president’s party. Since 1934, the average midterm loss for the president’s party is 30 House seats and 4 Senate seats. 

Democrats need to net 23 seats to win the majority in the House. Polling indicates that 50–60 seats, most of which are held by Republicans, are very competitive. As a result, Democrats are feeling optimistic about their chances. Nevertheless, many voters do not start paying attention to congressional races until the fall, so a lot can change.

Republicans have a tiny 51–49 majority in the Senate. Democrats (including two Independents who caucus with the Democrats) will defend 26 seats this fall, while only 9 Republican-held Senate seats are up for reelection. Though Democrats need to net just two seats to flip the majority, they appear to have a tough road ahead. Regardless of what happens, it’s likely that there will be an extremely narrow Senate majority again, with a margin of 51–49 or 52–48 to one side or the other. That means that—once again—it will be tough to get things done in 2019.

This report is current as of June 2018. Look for a future RIA Washington Watch from Schwab’s D.C. insider Michael Townsend. 

If you're thinking about becoming an independent advisor, consider a custodian that invests in your success. Contact us to learn more about the benefits of a custodial relationship with Schwab.