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It's the Moment of Truth for All Advisors: SEC Votes on Best Interest Today

By Rita Raagas De Ramos June 5, 2019

The SEC is voting today on its proposed Regulation Best Interest — a significant and somewhat divisive package of regulations that will, for the first time, obligate brokers to work in the best interest of their clients.

On one hand, supporters of Reg BI — mostly broker-dealers and their lobby groups — laud the best interest standard as a step up from Finra’s suitability rule that requires brokers to recommend investments that are suitable to their clients.

On the other hand, critics of Reg BI — mostly RIAs and investor protection groups — lament that the proposal dosen’t explicitly require brokers to be held to a fiduciary standard. While both the Reg BI proposal and the fiduciary standard require the financial professionals to work in the best interest of their clients, the best interest standard is required only at the time a recommendation is made while the fiduciary standard entails an ongoing duty of care and loyalty.

Robert Colby, chief legal officer of Finra — which will be monitoring and enforcing Reg BI compliance — has described the release of the final rules as an “an epical moment, a critical time for the regulation of broker-dealers.”

Finra president and CEO Robert Cook has said the self-regulator will have exam oversight on the requirements in Reg BI that are relevant to broker-dealers.

An obvious important thing to look for right away is whether the SEC decided to use the word fiduciary after all.
Evan Charles
Bank of America

But what exactly the final Reg BI rules will contain is known only to the SEC and staff involved in this particular rulemaking until its open meeting begins at 10:00 am EST. Whether the SEC has kept the proposals intact, tweaked them or significantly altered them will be revealed at today’s open meeting.

The proposed package

The Reg BI package proposed by the SEC in April last year came in three parts. It establishes a best interest standard of conduct for brokers, interprets the fiduciary standard for investment advisors, and creates a new Customer Relationship Summary form aimed at clearly stating to clients if they are dealing with a broker-dealer or an investment advisor.

First, the proposed best interest rule requires brokers 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 their own financial or other interest ahead of the retail customer.

The proposed rule requires brokers to discharge this duty by complying with three specific obligations:

  • Disclosure obligation: Disclose to the retail customer the key facts about the relationship, including material conflicts of interest.
  • Care obligation: Exercise reasonable diligence, care, skill and prudence, to understand the product; have a reasonable basis to believe that the product is in the retail customer’s best interest; and have a reasonable basis to believe a series of transactions is in the retail customer’s best interest.
  • Conflict of interest obligation: Establish, maintain and enforce policies and procedures reasonably designed to identify — and then, at a minimum, to disclose and mitigate, or eliminate — material conflicts of interest arising from financial incentives. Other material conflicts of interest must be at least disclosed.

Second, the proposed package includes an interpretation of the investment advisor’s fiduciary duty. The proposed interpretation reaffirms — and in some cases clarifies — certain aspects of the fiduciary duty investment advisors owe their clients.

Third, the proposed package requires investment advisors and broker-dealers (and associated persons of broker-dealers) to provide retail investors with a customer relationship summary. Simply put, this is meant to make it clear to investors whether they are dealing with an investment advisor or a broker-dealer. This standardized disclosure form — to be a maximum of four pages long — requires an explanation of the principal types of services offered; the legal standards of conduct that apply to the investment advisor or the broker-dealer (whichever relationship applies); the fees a client might pay; and certain conflicts of interest that may exist.

The need to clarify the relationship with the client includes a proposal to bar broker-dealers and their associated persons from referring to themselves as either “advisor” or “adviser” unless they are specifically also registered as investment advisors with the SEC. This would mean eliminating such references in any form on all materials, including business cards, firm websites and marketing materials. The SEC notes that the loose use of the terms "advisor" and "adviser" by broker-dealers may have led retail clients to believe they were dealing with investment advisors.

How will Reg BI impact Finra’s suitability rules?
Norm Ashkenas
Fidelity Brokerage Services

What the SEC is voting on today

Today the SEC is voting on the three components of its proposed Regulation Best Interest package. The SEC also threw in a fourth item for voting on the agenda.

The first vote will be on whether to adopt a new rule to establish a standard of conduct for broker-dealers and natural persons who are associated persons of a broker-dealer when making a recommendation to a retail customer of any securities transaction or investment strategy involving securities.

The second vote will be on whether to adopt new and amended rules and forms to require registered investment advisors and registered broker-dealers to provide a brief relationship summary to retail investors.

The third vote will be on whether to publish a Commission interpretation of the standard of conduct for investment advisors.

The fourth item is on whether to publish an SEC interpretation of the solely incidental part of section 202(a)(11)(C) of the Investment Advisers Act of 1940.

Has the SEC defined best interest to mean something more than suitability, which is currently not the case?
Barbara Roper
Consumer Federation of America

That part defines “investment adviser” as “any person who, for compensation, engages in the business of advising others, either directly or through publications or writings, as to the value of securities or as to the advisability of investing in, purchasing, or selling securities, or who, for compensation and as part of a regular business, issues or promulgates analyses or reports concerning securities.”

It goes on to state that “any broker or dealer whose performance of such services is solely incidental to the conduct of his business as a broker or dealer and who receives no special compensation” isn’t considered an investment advisor.

Voting on the items are SEC Chairman Jay Clayton and Commissioners Robert Jackson Jr. (D), Hester Peirce (R) and Elad Roisman (R).

What industry stakeholders are watching for

The first thing Evan Charles, associate general counsel at Bank of America, will be looking for — “an obvious important thing to look for right away” — is whether the SEC decided to use the word fiduciary after all.

After searching for the presence or absence of the word fiduciary, Charles says “The most basic part of what we’ll be looking for is ‘Did they keep the framework the same?” Or “Are they taking away or adding obligations?”

Charles — who describes Reg BI as “a fundamental change to the broker-dealer model in terms of standard of care” — will also check to see if the SEC incorporated any suggestions to the final rules.

Norm Ashkenas, chief compliance officer at Fidelity Brokerage Services, says he would want to find out how Reg BI impacts Finra’s suitability rules.

Finra executives, including Cook, have said the suitability rules may be scrapped if they become redundant because of Reg BI.

The worst thing the SEC could do when interpreting the standard of conduct for advisors would be to water down the fiduciary duty.
Karen Barr
Investment Advisor Association

Barbara Roper, director of investor protection at the Consumer Federation of America and a member of the SEC’s Investor Advisory Council, says she wants to know “whether the SEC has defined best interest to mean something more than suitability, which is currently not the case.”

Roper also wants to know — among a host of unanswered questions — whether Reg BI beefs up the obligation to mitigate conflicts by making clear that disclosure alone would not satisfy the obligation.

Karen Barr, president and CEO of the Investment Adviser Association, says she’s watching out for how the SEC has interpreted the standard of conduct for investment advisors.

“The worst thing the SEC could do” when interpreting the standard of conduct for investment advisors would be to “water down the advisors’ fiduciary duty.”

Barr says she wants the SEC to harmonize the broker and advisor standards of conduct by raising the bar for brokers, not lowering it for advisors.


Regulation Best Interest Package: What the SEC is Voting on Today

Item 1: Regulation Best Interest — Standard of Conduct for Broker-Dealers Whether to adopt a new rule to establish a standard of conduct for broker-dealers and natural persons who are associated persons of a broker-dealer when making a recommendation to a retail customer of any securities transaction or investment strategy involving securities.

Item 2: Form CRS Relationship Summary Whether to adopt new and amended rules and forms to require registered investment advisers and registered broker-dealers to provide a brief relationship summary to retail investors.

Item 3: Standard of Conduct for Investment Advisers Whether to publish an SEC interpretation of the standard of conduct for investment advisers.

Item 4: Interpretation of "Solely Incidental" Whether to publish an SEC interpretation of the solely incidental prong of section 202(a)(11)(C) of the Investment Advisers Act of 1940.