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This is why the SEC doesn’t want to define “best interest”

By Crucial Clips     June 27, 2018
The following text is a transcript of a portion of a speaker's presentation made at an industry conference or during an interview. This transcript solely represents the view of the individual who spoke, and not the view of Financial Advisor IQ or any other group.
Source: FA-IQ, Jun. 27, 2018 

RITA RAAGAS DE RAMOS, SPECIAL PROJECTS MANAGER, FA-IQ: The most common criticism of the SEC’s proposed Regulation Best Interest is the watchdog’s omission of what is meant by “best interest” in the context of what's expected of broker-dealers held to this standard.

Instead of defining best interest, the proposal simply states what is required of broker-dealers. They must 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 their own financial or other interest ahead of the retail customer. And they must perform this duty by complying with disclosure, care and conflict of interest obligations.

JAY CLAYTON, CHAIRMAN, SEC: Good Afternoon, this is an open meeting of the Securities and Exchange Commission under the Government in the Sunshine Act.

RITA RAAGAS DE RAMOS: Four of the five SEC commissioners – all except SEC Chairman Jay Clayton – said at the rule’s unveiling in April that the term "best interest" should have been defined because the ambiguity would lead to difficulties in compliance and enforcement, as well as confusion among investors.

KARA STEIN, COMMISSIONER, SEC: What does the proposed rule do? Let’s start with its name — Regulation Best Interest. This name implies that when broker-dealers give advice they will be required to put their customers’ interests ahead of their own. Unfortunately, this is not the case under today’s proposal. Despite repeated requests to define what best interest means in the rule text, it was decided that there was no need to define it.

MICHAEL PIWOWAR, COMMISSIONER, SEC: This lack of clarity is worrisome and could undermine our goal of preserving retail investors’ ability to access different types of financial services. On a basic level, ambiguity in this rule would make it difficult for broker-dealers to know how to comply with its requirements, which could then lead to disparate treatment of retail investors or a decision to stop offering transaction-based services.

RITA RAAGAS DE RAMOS: Dalia Blass of the SEC said that although the SEC didn’t define best interest, it has defined the contours of the obligation.

Blass said “a principles-based standard can serve Main Street investors well.” And that approach would provide “valuable flexibility” in recognizing “how customers vary from each other and how the industry may change over time.”

RITA RAAGAS DE RAMOS: At the Finra annual conference in Washington D.C. in May, Chairman Clayton said that 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.”

JAY CLAYTON: I think it’s reasonable for an investor to expect, that you’re going to tell them how they are going to make their money and not put your interest ahead of theirs.

RITA RAAGAS DE RAMOS: Clayton said the importance of preserving the investors’ different relationships with financial professionals is one reason it would be better to hold broker-dealers to a best interest standard instead of a fiduciary standard.

According to Clayton, calling the proposed rule fiduciary instead of best interest, and then defining the terms would not make it clear that the investor’s relationship with a broker-dealer is different from the investor’s relationship with an advisor. He said this is an important distinction to make, not just for showing the difference between the two relationships but also to preserve the broker-dealer model.

Also at the Finra annual conference, the SEC’s Brett Redfearn challenged critics who complain that the SEC didn’t define the term to “look closer.”

He said “best interest means what it says." Beyond that, he said it is a "facts-and-circumstances determination, not a check-the-box compliance exercise.”

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

Indeed, some lawyers say defining best interest could be more detrimental, compliance-wise, because broker-dealer firms have different business models and there is no one-size-fits-all-investors when it comes to recommending investment strategies or products.

However, SEC Commissioner Robert Jackson Jr., has said that “there should be no confusion” about the duty that investors are owed.

ROBERT JACKSON JR., COMMISSIONER, SEC: As written, the standard is potentially confusing, and I worry that it may be interpreted to permit conflicted advice to taint the investment decisions crucial to Americans’ futures. Moreover, I worry that lawyers will use this ambiguity to defend broker conduct that has no place in our markets — a result that is good for brokers and their lawyers but not for investors.