It does add paperwork for advisors already subject to the fiduciary standard as well as for broker-dealers.
Those looking to the Securities and Exchange Commission (SEC) for clarity, uniformity and broader investor protections when it comes to offering investment advice under the recently adopted Regulation Best Interest finally have an answer.
Broker-dealers will now be subject to a “best interest” standard at the time a product recommendation is made under Regulation Best Interest or Reg BI, for short. Registered Investment Advisors (RIAs) remain subject to the fiduciary standard under the Advisers Act. The bottom line is that brokers and advisors continue to be governed by two standards.
There is some overlap. Advisors who are dual-registered with a broker-dealer and RIA would be required to comply with Reg BI only when making a recommendation in their capacity as a broker-dealer, which was spelled out in the SEC’s proposal in 2018. Approximately 61% of registered financial professionals are employed by dually-registered entities, the SEC said in its original April 2018 proposed rule.1
Some of The Details
The SEC voted 3-1 on June 5 to adopt Reg BI. The rule requires broker-dealers to act in the best interest of a retail customer when making a recommendation of any securities transaction or investment strategy involving securities to a retail investor.
The rule elevates the broker-dealer standard of conduct beyond existing suitability obligations and makes it clear that a broker-dealer may not put its financial interests ahead of the interests of a retail customer when making recommendations. It also requires RIAs and broker-dealers to provide retail investors with a new customer relationship summary, known as Form CRS, at the beginning of their relationship.
In moving to a best interest standard from that of a suitability requirement, the SEC sought to resolve issues and remove potential conflicts of interest from current regulations governing broker-dealers’ conduct.
This includes policies and procedures designed to mitigate conflicts that could be an incentive for brokers to place their interests ahead of their clients; preventing material limitations on how firms limit product menus and promote proprietary products; and eliminating sales contest, quotas, bonuses and non-cash compensation of specific products within a limited time period.
Another important facet of Reg BI is that it includes an interpretation by the SEC on the meaning of the so-called “solely incidental” prong of the Advisers Act. According to the SEC, this was intended to more clearly delineate when a broker-dealer’s performance of advisory activities causes it to become an investment adviser within the meaning of the Advisers Act.
SEC Chairman Jay Clayton said the rulemaking package will bring the legal requirements and mandated disclosures for broker-dealers and investment advisers “in line with reasonable investor expectations, while simultaneously preserving retail investors’ access to a range of products and services at a reasonable cost.”
Already Some Fallout
Questions arise about whether the standards under Reg BI and the fiduciary standard will lead to a clear understanding about the services financial professionals provide when advising and recommending products as part of an ongoing fee-based relationship and one that is commission-based and transactional.
For example, some contend the SEC should have imposed an ongoing monitoring requirement for broker-dealers, rather than the “solely incidental” interpretation excluding broker-dealers under the Advisors Act. You can find this and other arguments against Reg BI not going far enough here.2
In a July 8 speech, SEC Chairman Jay Clayton said the activity of a broker-dealer agreeing to provide continuous monitoring of a customer account would subject the broker-dealer to regulation as an investment advisor – effectively prohibiting brokers from providing retail customers with advice without registering as investment advisers.
That would mean less access and choice, and higher costs, for retail customers, according to the SEC chairman. “I believe investors should be able to choose whether they want ongoing monitoring services and whether to incur the cost of those services,” he said in the speech.3
Within the financial community, the timing of Regulation BI has also led to the delayed enforcement of a separate fiduciary mandate proposed by the Certified Financial Planner Board of Standards. That’s partly because dually-registered members holding the designation required more time to modify their policies and systems to comply with the new rule. Some large brokerages had also, in the past, threatened that they would consider abandoning their support for the designation.4
The compliance date for the CFP Board’s Code of Ethics and Standards of Conduct is now in line with the SEC’s June 30, 2020 Reg BI compliance date. The cornerstone of the Code and Standards is CFP® professionals’ duty to act as fiduciaries and in the best interests of their clients at all times when providing financial advice. The new standards go into effect Oct. 1.5
Some Work to Do
Financial firms will also need to come up with policies and language for the rule’s Form CRS Relationship Summary requirement. According to the SEC, investment advisors and broker-dealers will be required to deliver the summary at the beginning of their relationship with clients.
Among other things, firms will summarize information about services, fees and costs, conflicts of interest, their legal standard of conduct, and whether or not the firm and its financial professionals have a disciplinary history. It is also slated to include a standardized question-and-answer format to help promote comparison by retail investors that’s distinct from existing disclosures. The relationship summary will also let firms use “layered disclosure” so that investors can more easily access additional information, according to the SEC.
The summary is limited to two pages, or four pages for dual registrants. That may not be much space for what the SEC is requiring. “It is unclear whether it is practical, or even possible, to disclose such information in a paper-based format within these page constraints. While the SEC permits hyperlinks and QR codes to be embedded in the text of a paper-based summary, questions remain as to the likelihood that retail investors would separately access the links provided,” the law firm Stradley Ronon Stevens & Young wrote in a June 18 Client Alert.6
Regulation Best Interest and Form CRS become effective 60 days after being published in the Federal Register. There is a transition period until June 30, 2020 to provide firms with “sufficient time” to come into compliance, the SEC says.7
- Regulation Best Interest, Proposed Rule. The Securities and Exchange Commission. April 18, 2018. Retrieved from: https://www.sec.gov/rules/proposed/2018/34-83062.pdf?mod=article_inline
- “SEC’s Clayton hits back at Reg BI critics,” Kenneth Corbin, Financial Planning. July 11, 2019. Retrieved from: https://www.financial-planning.com/news/sec-chairman-jay-clayton-hits-back-at-reg-bi-critics
- Regulation Best Interest and the Investment Adviser Fiduciary Duty: Two Strong Standards that Protect and Provide Choice for Main Street Investors. The Securities and Exchange Commission. Speech by Chairman Jay Clayton, Boston, Massachusetts. July 8, 2019. Retrieved from: https://www.sec.gov/news/speech/clayton-regulation-best-interest-investment-adviser-fiduciary-duty
- “CFP Board Delays Enforcement Date for New Standards,” Diana Britton, WealthManagement.com. July 16, 2019. Retrieved from: https://www.wealthmanagement.com/regulation-compliance/cfp-board-delays-enforcement-date-new-standards
- Roadmap To The Code Of Ethics & Standards Or Care. Certified Financial Planner Board of Standards, Inc. Retrieved from: https://www.cfp.net/docs/default-source/for-cfp-pros—professional-standards-enforcement/cfp-board-roadmap-to-code-and-standards.pdf?sfvrsn=6
- SEC Adopts Form CRS Relationship Summary Requirement,” Stradley Ronon Stevens & Young, LLP. Client Alert. June 18, 2019. Retrieved from: https://www.stradley.com/insights/publications/2019/06/risk-and-reward-june-18-2019
- SEC Adopts Rules and Interpretations to Enhance Protections and Preserve Choice for Retail Investors in Their Relationships With Financial Professionals,” The Securities and Exchange Commission. June 5, 2019, Press Release. Retrieved from: https://www.sec.gov/news/press-release/2019-89
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