Fully staffed SEC focusing on exams and cyber

Submitted by Brian.Lavelle on March 16, 2018

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.

•    Tax law: Decision to drop FIFO requirement is good news, but loss of deduction for advisory fees catches investors off guard.
•    Budget deal: Debt ceiling hike brings welcome, if temporary, relief for markets.
•    Regulatory issues: More fiduciary rule changes loom; SEC exam to focus on cybersecurity, protections for retail investors. 

Michael Townsend

The past three months have seen a frenzy of activity in Washington, beginning in December with Congressional approval of the most sweeping overhaul of the tax code in three decades. The new law, which went into effect January 1, reduces both individual and corporate tax rates and substantially changes dozens of tax deductions and credits.

Tax law a mixed bag for advisors and investors

The overhaul will affect virtually every taxpayer:

  • Changes to corporate and individual tax rates should benefit advisors and their clients. But the new law eliminates the deduction for investment advisory fees, a move that has caught many investors by surprise.
  • Another provision changes the taxation of pass-through businesses such as S corporations and limited liability companies. The IRS is expected to issue regulations and guidance on the provision later this year. Meanwhile, advisors should work with their tax professional to determine the provision’s impact.
  • The most significant development for investors and advisors was ultimately dropped from the final legislation. Earlier versions of the bill contained a provision that would have required investors to use the first in, first out (FIFO) method when calculating their cost basis. Schwab and other financial companies helped lawmakers recognize the importance of preserving investor choice, and the FIFO requirement was not included in the final legislation.

Budget deal 

In January, another budget impasse produced a three-day government shutdown that was widely panned by both Democrats and Republicans. However, the shutdown led to a surprise two-year budget agreement in early February that raised federal spending levels for the rest of FY 2018 and all of FY 2019. This deal should end, for now, the cycle of short-term agreements—five since last October—that keep the federal government open and operating for a few weeks at a time. 

But there is one more hurdle to cross. The February agreement funds government operations through March 23, by which time Congress needs to approve 12 appropriations bills (likely to be packaged into one, giant “omnibus” bill) that allocates new spending amounts on an agency-by-agency and program-by-program basis. Lawmakers are optimistic they can hit the deadline, but they might pass another temporary funding agreement if they need an extra week or two to finalize negotiations. 

Action on the debt ceiling

For the markets, perhaps the most significant aspect of the February agreement was the decision to suspend the debt ceiling until March 2019. Congress faced a deadline to either act or risk the United States defaulting on its debts for the first time in history. In recent years, uncertainty over whether Congress would raise the debt ceiling has sparked significant market volatility. Now the markets know that this potential battle is off the table until 2019. 

The remaining 2018 legislative agenda gets trickier. Democrats believe they are on the cusp of a wave election this fall that could sweep the party into power in both the House and Senate. As a result, Democrats may not be as inclined to work with Republicans on traditionally bipartisan issues, such as infrastructure or a potential new retirement savings bill that would encourage lifetime income disclosure and make it easier for small businesses to offer retirement plans to their workers. Given the current partisan environment on Capitol Hill, we think legislative victories will be few and far between in the months ahead.

Key regulatory issues for advisors

Things should be much busier on the regulatory side. Topping the watch list for many advisors is the seemingly never-ending debate over the fiduciary standard. The biggest news is the decision by the U.S. Court of Appeals for the 5th Circuit to invalidate the entire Department of Labor (DOL) fiduciary rule in a decision handed down on March 15.  The decision means the new rule is no longer in effect but leaves a lot of questions about what will happen next.  There could be an appeal of the decision.  The DOL could try to revive the rule in a different form.  Schwab and others are just beginning to analyze this news and consider the implications for advisors and investors. Advisors should stay the course as this plays out.  

Meanwhile, the U.S. Securities and Exchange Commission (SEC) is contemplating action to harmonize broker-dealers and investment advisors under a single fiduciary standard. Chairman Jay Clayton said last fall that the SEC has been “working on a fiduciary rule and exploring it for brokers and investment advisors. It’s a priority for me to address this space in light of the action that the Department of Labor took to step into this space.” With two new commissioners—Republican Hester Peirce and Democrat Robert Jackson took the oath of office in January—the agency is fully staffed for the first time since October 2015 and is expected to propose a fiduciary rule as soon as the second quarter of this year. The implications of the court’s recent decision regarding the DOL standard remain unclear. Clayton and Labor Secretary Alexander Acosta say their staffs are working together on the fiduciary issue, but it remains to be seen whether the agencies can produce a standard that works across both retirement and non-retirement accounts. Meanwhile, a number of states—including Maryland, Nevada, and New York—are considering their own fiduciary-related proposals. 

SEC exam focus: Protecting investors

The SEC’s Office of Compliance Inspections and Examinations issued its 2018 exam priorities in early February, with cybersecurity and protections for retail investors, especially seniors, among the top priorities. Exams will focus on the disclosure of fees and expenses to retail investors, supervision of those selling products and services to retail investors, and the execution of fixed income orders. The SEC also announced that it is closely monitoring the growing craze for cryptocurrencies and initial coin offerings “to ensure that investors receive adequate disclosures about the risks associated with these investments.”

On the cybersecurity front, the SEC in recent years has aggressively scrutinized how advisor firms and other financial companies are protecting customer information from hackers and other cyber threats. In August, the agency published a Risk Alert that outlined successes and shortcomings in exams of broker-dealers and advisor firms. Weeks later, the SEC’s enforcement division launched a new cybersecurity unit, another sign of how seriously the agency is taking the issue. In February, the SEC issued new guidance for public companies on disclosing cybersecurity risks and data breaches more clearly and quickly to the public. Expect this issue to remain front and center in 2018 and beyond.

New compliance requirements

RIA firms that have not already experienced the new Form ADV will do so this year. Under new filing requirements approved in October, firms must update their forms within 90 days of fiscal year end—March 30 for RIA firms operating on a calendar year. The form requires firms to issue new information about their numbers of clients and assets in each of several categories and to make new disclosures about separately managed accounts, social media, and multiple offices. These changes are another example of the important and ever-growing compliance responsibilities facing today’s RIAs. 

This report is current as of March 16, 2018.  Advisor Services™ is committed to keeping you abreast of the latest happenings in Washington. 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.