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SEC Chair: Government Should Not Drive Away the Broker-Dealer Model

By Rita Raagas De Ramos May 23, 2018

SEC chairman Jay Clayton defended the watchdog’s proposed Regulation Best Interest package on Tuesday as a set of rules that can meet “reasonable” expectations of investor protection – especially of mom-and-pop investors – while preserving the transaction-based relationship model of broker-dealer firms.

“I am concerned over the reports that I hear that the availability of the broker-dealer is diminishing. There is less of that type of relationship available, which I don’t think is a good thing because there are clearly many people for whom that relationship is a more economical model than the investment advisor model. That’s what our research shows,” Clayton said during a fireside chat session with Finra CEO Robert Cook at the self-regulator’s annual conference in Washington, D.C.

“I don’t want to see government activity drive away a service that is better for them,” Clayton added, referring to investors who benefit from the broker-dealer model.

Clayton stressed, however, that at the same time, “I want to make sure that they are getting the protections that they expect.”

The SEC’s proposed Regulation Best Interest package establishes a best interest standard of conduct for broker-dealers, interprets the fiduciary standard for investment advisors, and creates a new Customer Relationship Summary form that will state if clients are dealing with a broker-dealer or an investment advisor.

The proposed rule requires broker-dealers to have a duty to act in the best interest of retail customers when making a recommendation – at the time the recommendation is made – without putting his/her own financial or other interest ahead of the retail customer. And broker-dealers are required to perform this duty by complying with disclosure, care and conflict of interest obligations.

Clayton went on to talk about the “reasonable expectations” of a “reasonable investor,” and why he believes the proposed Regulation Best Interest package meets those expectations.

“What do they expect in a reasonable commercial relationship? They can expect the core principle that the professional can’t put their interest ahead of the investors,” Clayton said.

Clayton said the inclusion of a requirement for financial professionals to inform their clients whether they are dealing with them in a broker-dealer or advisor capacity is something he considers as “critical” in protecting investors.

He described broker-dealers as typically having “transaction-based relationships” with their clients while advisors have “portfolio, time-based relationships” with their clients.

In fact, those two distinct types of relationships are among the reasons Clayton said he believes it was better to hold broker-dealers to a best interest standard instead of a fiduciary standard.

“I thought calling it both fiduciary [instead of best interest] and then defining [the terms] would not make it clear that the relationship is different,” Clayton said.

“It is important for investors to understand that the relationship model of broker-dealers is different from the relationship model of investment advisors. If I use the same term, they will think they have the same relationship,” he added.

Despite the proposal being called Regulation Best Interest, “it is definitely a fiduciary principle; just like the fiduciary duty in the investment advisor space is a fiduciary principle,” Clayton said.

Clayton noted that even the term fiduciary can have various interpretations.

“Fiduciary can mean different things in a lot of different contexts,” he said. “I wanted the level set so that when you hear fiduciary in the investment advisor space, this is what it means, and when you hear the best interest that we’re proposing in the broker-dealer space, this is what it means.”

During the chat and on the sidelines of the conference, Clayton stressed that the SEC wants to get the comments of anyone who has anything to say about the proposed Regulation Best Interest package.

Clayton told reporters that whether the proposed package remains as is, is tweaked or is drastically changed “depends on what comes in” during the 90-day comment period that ends on August 7.

“I am very interested in the comments that come in, whether people think this current proposal fits their current relationships with their clients,” he said. “I also want to understand, are we doing violence to the investment advisor model in any way? Are we doing violence to the broker-dealer model in any way? People should comment.”

In addition to seeking comments, Clayton said he had a roundtable discussion with investors in New York when the SEC staff was drafting the proposed Regulation Best Interest package. And he said there will be more of these roundtable discussions in Atlanta, Miami, Houston and Denver.

“What’s important to me is [to know] are we matching our rules to what a reasonable investor would expect,” Clayton said. “These are very illuminating exercises – just to sit down with somebody who I would consider an ordinary investor with their retirement nest egg and talk to them about what they expect.”

During the fireside chat session, Finra’s Cook commented that Clayton has been taking into consideration the “Mr. and Mrs. 401(k) type investor” in rulemaking at the SEC.

“It’s a perspective that helps me in decision making,” Clayton said. “I started saying that somebody with long-term exposure to our capital markets, they want efficiency, they want integrity, they want protection. How do we do this in the way that’s best for them? It’s a good lens for decision-making.”

Jay Clayton

Separately at the Finra conference, Brett Redfearn, director of the SEC’s Division of Trading and Markets, said the SEC recognizes that broker-dealers are “already subject to extensive rules that govern the advice that they can give.”

“To enhance the quality of brokerage advice and preserve the brokerage advice model for investors, the Commission needed to act in a way that recognized the range of services and the various types of advice – one-time, episodic to more frequent – that a broker-dealer may provide its retail customers,” he said.

Redfearn said he “would challenge” critics who complain that the SEC didn’t define best interest to “look closer.”

“Best Interest means what it says. You must act in the best interest of your client, and not put your own interests in front of theirs. Beyond that, it is a facts and circumstances determination, not a check-the-box compliance exercise,” he said

Redfearn says it was better not to be prescriptive with the definition of best interest because “what is in the best interest of one customer may not be in the best interest of another.”