Regulatory Outlook | 06.06.19
SEC Approves New ‘Best Interest’ Standards for Brokers And Advisers: What You Need to Know
The Securities and Exchange Commission's conduct-standards package, better known as Regulation Best Interest, or "Reg BI," was approved on June 5. The rules were first proposed last spring and circulated for comment last summer (see related article).
At the heart of the multi-part package is a "best interest" standard for brokers who, until now, had been subject to a "client suitability" standard. Under that prior standard, brokers were required to provide advice deemed suitable to the client's financial situation. Reg BI now requires brokers to put clients' financial interests ahead of their own and, with that sentiment in mind, to mitigate conflicts that could undermine the alignment of interests.
A major component of the package and means of carrying out conflict mitigation is what is known as the client relationship summary, or Form CRS.
Form CRS requires brokers to disclose to retail investors: the nature and scope of their services, fees, conflicts of interest and disciplinary history.
The package includes a broker-friendly interpretation of "solely incidental" that should give some latitude to registered representatives when it comes to certain borderline advice-dispensing activities that could otherwise be viewed as constituting crossing over into the terrain of registered investment adviser.
The provision, found in the Investment Advisers Act of 1940, exempts broker-dealers giving investment advice from registering under the Advisers Act if their advice is solely incidental to the conduct of their business as a broker-dealer and they don't receive special compensation for the advice.
For many years, according to Rick Fleming, SEC's investor advocate, the agency has given the words “solely incidental” almost no meaning.
"Broker-dealers have been allowed to engage in activities that look very much like the investment adviser business model," Fleming said in a post on the SEC’s website June 5. "It is not surprising, then, that most investors don’t understand the basic differences between investment advisers and broker-dealers.”
"In issuing its new interpretation of ‘solely incidental,’ the SEC does not make clear what problem it is attempting to solve, and it fails to solve the well-known problem of investor confusion,” Fleming said. “The SEC had an opportunity to help investors by brightening the lines between investment advisers and broker-dealers, but instead ... formalized its longstanding acquiescence to the preferences of the brokerage industry."
Fleming added, however, that Regulation Best Interest is an improvement over the existing standard of conduct for broker-dealers.
"Reasonable people will differ on the utility of the new ‘best interest’ standard of conduct,” he said. “And whether it is much, if any, improvement over the current suitability standard.
Fleming said he thinks Reg BI will improve upon the suitability standard by:
- Eliminating sales contests and requiring mitigation of other conflicts of interest that were permitted under the suitability standard
- Requiring better disclosure about conflicts of interest
- Requiring brokers to consider the costs to the investor of a recommended product and whether, in light of those costs and other factors, the recommendation is in the best interest of the customer
- Requiring more careful review of limited product menus