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It’s Official! SEC Pushes Through with Regulation Best Interest Standard for Broker-Dealers

By Rita Raagas De Ramos June 5, 2019

The SEC has voted to approve its Regulation Best Interest rule, which requires broker-dealers to act in the best interest of their clients.

The new rule requires broker-dealers to comply with the best interest standard when making a recommendation to a retail customer of any securities transaction or investment strategy involving securities.

SEC chairman Jay Clayton said at the open meeting today that the feedback the Commission received since the rule proposal was released in April last year "solidified" his view that Reg BI has "the right framework" for the standard of conduct for broker-dealers.

Clayton said he believes the SEC has taken the "right approach" because Reg BI "incorporates fiduciary principles but is appropriately tailored" to the broker-dealer business model.

The "overriding" issue the SEC addressed today with the vote is the obligation of financial professionals, which "has been at the heart of our mission" but has been a "vast, multifaceted, complex" issue, according to Clayton.

"Today we elevate, enhance, clarify these obligations in a comprehensive manner," Clayton said.

Clayton acknowledged that the SEC's "authority" over the standard of conduct of financial professionals "is not exclusive," noting "we enjoy cooperation" with other regulators, such as state regulators.

"But no other body has comparative authority over these matters," Clayton said.

The SEC has taken the right approach because Reg BI incorporates fiduciary principles but is appropriately tailored to the broker-dealer business model.
Jay Clayton
SEC

The best interest standard is considered by the SEC and advocates of the rule as a step up from the suitability standard imposed through a Finra rule that requires recommendations to merely be suitable for clients.

However, critics of Reg BI say the best interest standard is misleading because it doesn't provide investors the protection the term implies, conflicts of interests can be satisfied by disclosures and it merely codifies existing obligations under Finra rules.

At the open meeting, Brett Redfearn, director of the SEC's Division of Trading and Markets, said that among other things, Reg BI "explicitly" requires that the broker-dealer act in the best interest of client and it "explicitly" requires the consideration of cost of investment advice.

Repeated by several SEC staff, including Clayton, during the open meeting was how Reg BI will "help improve investor protection and decision-making while preserving retail investor choice."

SEC staff at the open meeting revealed the "key changes" to the final rule compared with the proposals put forward in April last year. These include, but are not limited to:

  • Modifying the scope of Reg BI to apply to account recommendations, including rollovers to IRAs. "These recommendations are often provided when investors are making a critical financial decision on retirement savings," an SEC staffer said.
  • Requiring broker-dealers to provide full and fair disclosure of all material facts relating to the relationship with the retail customer and with regard to conflicts of interest, which must be provided in writing. Oral disclosure is acceptable only if the broker-dealer has already provided a written summary disclosure.
  • Adding cost as a factor for consideration in conflict of interest. But this doesn't require that the least expensive recommendation be made by a broker; it's not the only factor.

Meanwhile, the SEC staff recommended that "the Commission presume" that a broker's use of the title advisor/adviser "is a violation" unless the broker is already dually registered as both a broker and an advisor.

At the open meeting, SEC Commissioner Robert Jackson Jr. (D) said Reg BI fails to protect investors who are facing the country's savings crisis and the "terrifying prospect of running out of money" upon retirement.

Jackson said he doesn't believe that Reg BI actually puts the investors' interest first. "The commission is wrapping a policy choice in legalese," he said.

Instead, Reg BI is no better that Finra's suitability standard, according to Jackson.

Jackson said he is also worried over how Reg BI would impact fiduciary rules at the state level.

"I’m deeply discouraged by how our rule may displace" state fiduciary rules, Jackson said, adding Reg BI "invites expensive and extensive litigation."

Reg BI fails to protect investors who are facing the country's savings crisis and the terrifying prospect of running out of money upon retirement.
Robert Jackson Jr.
SEC

Reg BI is the solution to the “the fundamental problem” the SEC was “trying to tackle,” which is "How do you provide advice in the face of conflict?” Lourdes Gonzalez, assistant chief counsel for sales practices, a division of the SEC’s trading and markets division, said at Finra’s annual conference in Washington, D.C. last month.

Ahead of today’s vote, the American Securities Association issued a statement lauding the SEC’s Reg BI for strengthening investor protection, improving accountability across the financial industry and instilling greater confidence in investors.

“By finalizing Reg BI and strengthening investor protections, the Commission will bring certainty to Main Street investors, working families saving and investing for a better future, and financial professionals across the country who do the right thing every day,” according to the ASA.

ASA also warns states pushing for fiduciary rules for broker-dealers – which the lobby group for financial services companies describes as “largely motivated by politics” – to back off.

The states “should recognize” that Reg BI “sets a national standard and must refrain from creating a patchwork of unworkable regulations that will directly harm investors and their local economies,” ASA says.

According to ASA, Reg BI improves investor protection by requiring financial firms and professionals to:

  • Put their customers' interests first by not placing their own interests ahead of their clients' interests;
  • Disclose necessary facts about relationships, including fees and compensation related to financial products they recommend;
  • Exercise diligence, care and skill when making recommendations of investment products; and
  • End high-pressure sales practices.

New Jersey, Nevada and Connecticut are among the states which have also set forth their own fiduciary rule initiatives after the Department of Labor’s fiduciary rule was vacated in Federal court last year. In April, the Maryland Senate Finance Committee overwhelmingly voted to recommend the rejection of a pending fiduciary bill that would have held brokers and related individuals to those standards.

Also ahead of the vote, the Insured Retirement Institute issued a statement of how Reg BI would benefit investors, based on the framework of the best interest standard. The Institute says Reg BI

  • Will be a substantial advancement in consumer/investor protection compared to existing law;
  • Will impose significant new regulatory implementation burdens on companies and advisors
  • Will rely on rigorous SEC and Finra enforcement mechanisms to protect consumers.

Critics of Reg BI, such as Barbara Roper, director of investor protection at the Consumer Federation of America, believe the best interest standard could do “more harm than good by misleading investors” about “providing protection the rule simply does not provide.” Roper is also a member of the SEC's Investor Advisory Council, which advises the SEC on regulatory priorities and other issues.

Finra already interprets its suitability standard as requiring brokers to make recommendations that are “consistent with his customers’ best interests,” Roper says. The SEC has explicitly stated that its new best interest standard simply codifies the existing obligation under Finra rules, she adds.

"Our objection is that [the SEC has] adopted a best interest standard in name only that will do nothing to change the way brokers evaluate and select investments to recommend but will mislead investors into expecting protections the rule does not deliver," Roper says.

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

Today, the SEC voted 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 was 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 was 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 was whether to publish a Commission interpretation of the standard of conduct for investment advisors.

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

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.

Here’s how the SEC commissioners voted on the proposed Reg BI package (for each item):

  • Chairman Jay Clayton – Yes
  • Commissioner Robert Jackson Jr. (D) – No
  • Commissioner Hester Peirce (R) – Yes
  • Commissioner Elad Roisman (R) – Yes

[Updated 1:30 pm EST]

Initial reactions to Reg BI are coming in.

Micah Hauptman, financial services counsel at Consumer Federation of America, says Reg BI is “a bait and switch on investors.”

“The SEC claims to be imposing a new best interest standard on brokers, but it won’t change any practices in the brokerage industry,” Hauptman says. “Instead, Reg BI simply codifies the existing standard under Finra rules, just like the brokerage industry asked them to.”

Hauptman says the investing public is “getting hoodwinked.”

“Instead of raising the standard for brokers, the SEC is dumbing down the standards on advisers. That’s clearly not what Congress intended in Dodd-Frank. I fear investors will be harmed considerably by the rules finalized today,” Hauptman says.

Reg BI is a bait and switch on investors. The SEC claims to be imposing a new best interest standard on brokers, but it won’t change any practices in the brokerage industry.
Micah Hauptman
Consumer Federation of America

In a statement, the CFA says it will use the next few days to carefully review the entire regulatory package in detail.

“This morning’s discussion made it clear that our top priority changes have not been adopted. In particular, we share Commissioner Robert Jackson’s concern that: “Rather than requiring Wall Street to put investors first, today’s rules retain a muddled standard that exposes millions of Americans to the costs of conflicted advice. Even worse, contrary to what Americans have heard for a generation, the Commission today concludes that investment advisers are not true fiduciaries. Today’s actions fail to arm Americans with the tools they need to survive the Nation’s retirement crisis. As a result, this regulatory package will mislead investors into expecting protections the rules do not deliver, putting investors at even greater risk.’”

“The SEC is throwing Mr. and Ms. 401(k) under the bus,” CFA’s Roper says.

“These new rules seriously erode the Commission’s traditional interpretation of the Advisers Act fiduciary standard, giving brokers virtually unlimited ability to act as advisors, while simultaneously failing to regulate them accordingly, and making it easier for brokers to mislead their customers into believing they are getting trusted, best interest advice when they are actually getting investing recommendations biased by toxic conflicts of interest,” Roper notes.

Roper says the modest steps the SEC appears to have adopted to enhance its proposed best interest standard for brokers – applying the standard to account opening recommendations, explicitly requiring brokers to consider costs, and tweaking the obligations that apply when brokers explicitly agree to monitor accounts – “cannot compensate for the standard’s fundamental weakness. Investors will suffer real financial harm as a result of this best interest bait and switch.”

“Now, more than ever, investors will need to be on their guard against brokers and advisers who seek to profit unfairly at their expense,” Roper says. “The good news is that there are many upstanding advisors who voluntarily embrace a higher standard than the Commission is willing to adopt and who are willing to commit to truly putting their clients’ interests first.”

Jay Shah, CEO of digital wealth management firm Personal Capital, believes Reg BI won’t generally be an effective investor protection measure.

“Some see the Best Interest standard as a step in the right direction, but it simply creates more air cover for bad behavior,” Shah says.

“The only way for the financial services industry to earn trust back from Americans is to fully embrace transparency and honesty. Financial advisors should always put the customers’ interests first, with unbiased advice and clear fees,” he notes.

Some see the Best Interest standard as a step in the right direction, but it simply creates more air cover for bad behavior.
Jay Shah
Personal Capital

Jamie Hopkins, director of retirement research, at Carson Group, which is which is dually registered as a broker-dealer and advisor, is concerned about the potential for Reg BI to mislead investors.

“While it looks like the SEC had the right goal in mind, the ending rule opens the door to confuse investors further rather than bring clarity around the differences between a fiduciary investment advisor and a broker, when it comes to receiving advice,” Hopkins says.

Hopkins says the proposed rule falls short of requiring brokers to act in a fiduciary manner, does not articulate the meaning of best interest and doesn’t go far enough to ban certain harmful sales practices.

“The new rule seems to allow brokers to continue being brokers and assert to consumers that they are not much different than registered investment advisors,” Hopkins says.

While it looks like the SEC had the right goal in mind, the ending rule opens the door to confuse investors further rather than bring clarity around the differences between a fiduciary investment advisor and a broker, when it comes to receiving advice.
Jamie Hopkins
Carson Group

As expected, broker-dealer lobby group Sifma welcomes to Reg BI.

“As written, the SEC’s Regulation Best Interest rule will impose a materially heightened standard of conduct for broker-dealers when serving retail clients. While principles based, the rule is specific with respect to the duty and obligations brokers owe to their clients, and what steps they must take to comply, including the obligation to eliminate, or disclose and mitigate, certain conflicts of interest,” Sifma president and CEO Kenneth Bentsen, Jr. says in a statement.

“Not even the so-called fiduciary standard under the Investment Advisers Act [of 1940] includes the obligation to eliminate or mitigate conflicts. It is undeniable that this rule will directly enhance investor protection and contribute to increased professionalism among financial service providers,” Bentsen adds.

Bentsen goes on to say that compliance with Reg BI will not be easy for the broker-dealer industry.

“Firms will need to make substantial changes,” Bentsen says. “The costs to implement will no doubt be significant, but, we believe, worthwhile to uniformly enhance investor protection to the level investors should and do expect, while preserving investor choice and access to investment advice.”

Sifma says the broker-dealer industry supports what it has identified as the key investor protection elements of the rule

  • Recommendations must be in the retail customer’s “best interest,” meaning that broker-dealers cannot put their interests ahead of the interests of the customer. Brokers will be held to that standard under the robust examination and supervision regimes of the SEC and Finra, as well as Finra’s arbitration forum.
  • Broker-dealers must either eliminate, or disclose and mitigate, material conflicts of interest, an even higher standard than the one that applies today to investment advisers.
  • Requires broker-dealers to exercise reasonable “diligence, care and skill” in making recommendations. These principles are the core of a broker-dealer’s “Care Obligation” in Reg BI. The totality of these new, stringent and elevated regulatory requirements will require brokerage firms to dramatically enhance their supervisory and compliance regimes to the benefit of retail investors.
  • Preserves access and choice for investors while providing significantly enhanced protections in areas that the now defunct DOL Fiduciary Rule sought to address. The rule includes all of the protections of the former DOL rule, including the duty of loyalty, duty of care and risk mitigation elements. But it is even more protective than the DOL rule because it applies to all retail brokerage accounts, not just qualified retirement accounts or IRA’s, and is backed by the accountability mechanism of SEC and FINRA examination and enforcement.

Kim Yurkovich, vice president for external media relations at Well Fargo Advisors, says the wirehouse believes retail investors deserve a best interest standard of conduct when receiving personalized investment advice.

“Wells Fargo has been a consistent and vocal advocate for the adoption of a standard of conduct that ensures retail investors’ interests are always put first, while also preserving access to the financial information, advice, and account choices they need to help them achieve their financial goals,” Yurkovich says.

Raymond James, which is dually registered as a broker-dealer and advisor, is supporting Reg BI.

“Raymond James has consistently supported a best interest standard for all account types with the oversight of a regulator with broad authority. We will be diligently reviewing the SEC’s final rule package with industry partners, which we expect will take some time,” the company says in a statement.

“Our primary focus is to provide financial advisors with ample time and support to implement any necessary changes to their individual practices to bring them in alignment with the new rules,” the company adds.

Nancy Anderson, senior vice president and head of wealth strategy, Calamos Wealth management, which is which is dually registered as a broker-dealer and advisor, says Reg BI is “a much-needed reform,”

Reg BI addresses conflicts of interest issues and sets a higher standard of diligence and prudence from brokers, according to Anderson.

Anderson believes the Form CRS will provide transparency because will be delivered by brokers and advisors at the beginning of the relationship with the client.

“From an investor perspective and consumer protection view, Reg BI gives investors the ability to make a choice when hiring a broker versus an advisor,” Anderson says.

A disclosure form showing the differences between brokers and advisors will help investors to understand the expected standard of conduct for advisors at the beginning of a relationship disclosing fees and costs, conflicts of interest, legal standard of conduct and whether a firm or its representatives have a disciplinary history according to the SEC fact sheet, according to Anderson.

“Reg BI will focus on the client’s interest first, providing fiduciary duty on the broker similar to the fiduciary duty that applies to investment advisers,” Anderson says.

“It will also raise the standard of care from suitability to quality advice. Suitability standards for brokers have allowed brokers to focus on the commission, revenue sharing and financial incentives to sell proprietary products creating conflict of interest,” she adds.

However, Anderson acknowledges that “although Reg BI requires policies and procedures that mitigate conflicts of interest, eliminating sales contest, sales quotas, bonuses or non-cash compensations based on specific products, compensation will always be an issue.”

The Certified Financial Planner Board of Standards took the opportunity to highlight that CFPs are held to a higher standard of conduct than Reg BI because of the organization’s own rules.

“Consumers should know that nearly 85,000 CFP professionals will be obligated to provide financial advice under a fiduciary standard,” the CFP Board says.

That particular fiduciary obligation is in CFP Board’s new Code of Ethics and Standards of Conduct, which will be effective October 1.

“Drawn from the common law of fiduciaries, it includes a duty of loyalty to place the clients’ interest above their own and the firm’s, a duty of care, and a duty to follow client instructions,” the CFP Board says. “This clear and simple standard – along with the entire Code and Standards – is consistent with CFP Board’s mission to benefit the public.”

The CFP Board says professional standards-setting organizations exist in part to set standards that go beyond those required by the law for the benefit of the public and the profession.

Those who comply with the CFP Board’s Code and Standards will not be in violation of Regulation BI, or any other existing laws and regulations, according to the CFP Board.

[Updated 4:00 pm EST]

Karen Barr, president and CEO of Investment Adviser Association, says Reg BI won’t alter the advisors’ “special relationship of trust and confidence with its clients.”

As fiduciaries, advisors continue to have “an affirmative duty of care, loyalty, honesty and the utmost good faith” to act in the best interests of their clients, according to Barr.

Barr notes that the IAA has “steadfastly maintained” that a new interpretation of the fiduciary duty in the Investment Advisers Act of 1940 is “unnecessary because that duty is widely understood and established in law, regulation and professional practice.”

“While we are pleased that the Commission seems to have made several of the clarifications we requested to the proposed interpretation, we would be disappointed if the Commission dropped the most effective, widely used, and straightforward articulation of the fiduciary duty – to put your client’s interest first at all times – an articulation that has long framed fiduciary duty,” Barr says.

Barr says IAA is also concerned about the scope of the “solely incidental” interpretation.

“It also remains to be seen whether this combined package will significantly alleviate investor confusion,” she says.

It remains to be seen whether the Reg BI package will significantly alleviate investor confusion.
Karen Barr
nvestment Adviser Association

Michael Silver, CEO at Baron Silver Stevens Financial Advisors, which is dually registered as a broker-dealer and advisor, says Reg BI must be explained in a “simple and understandable” way to the public.

“There should no longer be hidden fees and backdoor deals for financial advisors and Wall Street firms. The general public is ok paying a profession fees for good advice. The fees just need to be disclosed, fair, and reasonable,” Silver says.

“This is an opportunity for Wall Street and the financial advising community to earn back the trust and respect of the general public. We should be embracing some of this regulation with open arms,” he adds.

Lou Cannataro, founder and partner at Cannataro Park Avenue Financial, says while the debate over Reg BI has been “complex” for the industry, the issue is a “simple one for investors.

“The new regulations requiring more disclosure may be a step in the right direction be it not as demanding as prior proposed regulations,” Cannataro says.

An investor can eliminate any ambiguity very quickly by asking a simple question: ‘As my advisor, are you taking on fiduciary responsibility?’ The yes or no answer will provide clarity on the actual relationship.
Lou Cannataro
Cannataro Park Avenue Financial

“However, an investor can eliminate any ambiguity very quickly by asking a simple question: ‘As my advisor, are you taking on fiduciary responsibility?’ The yes or no answer will provide clarity on the actual relationship being proposed and the investor can decide to engage or work with someone else able or willing to take on that responsibility,” he adds.

Reacting to Reg BI, RBC Wealth Management-U.S. says; “We have always done what the rule is asking all firms to do – put the needs of clients first. Our intent is to comply fully with the new rules.”

This is a developing story ...

With reports from Garrett Keyes and Mrinalini Krishna