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Regulation and Compliance > Federal Regulation > SEC

SEC IM Chief Offers Clarity on Broker Conduct Standards

By Melanie Waddell

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As questions about the Securities and Exchange Commission’s new standard of conduct proposal are streaming in, the head of the agency’s Investment Management Division tackled a few of them in a Monday speech.

Questions have been posed about the new disclosure form, called the “Relationship Summary,” which is designed to educate investors about “whether they are talking to a broker-dealer, an investment advisor, or both and why that matters,” said Dalia Blass, head of the SEC’s Investment Management Division, at the Practising Law Institute’s Investment Management Institute in New York.

Commenters wonder whether the form would really be that helpful to investors and if its design could be improved, Blass said.

Her response: As to the first question, “I do believe a Relationship Summary would serve as a valuable tool for investors,” as it would “highlight key differences between broker-dealers and investment advisors, including (1) the principal types of services offered, (2) the legal standards of conduct that apply to each, (3) the fees the customer would pay, and (4) certain conflicts of interest that may exist.”

Advisors and broker-dealers, Blass added, “would also need to include relevant questions for investors to ask.”

Is there room for improvement? “We want investors, together with consumer groups and the financial professionals who serve them, to help us get it right,” Blass said, noting that the agency wants to also hear from experts in financial literacy, information design and marketing.

As to questions about why the “best interest” is not defined in the standard of conduct proposal’s Regulation Best Interest, or Reg BI, Blass stated that although the securities regulator has not defined the term “in the proposed rule text, we have defined the contours of the obligation: a broker-dealer cannot put its interests ahead of the retail customer’s and must comply with specific disclosure, care and conflict of interest obligations.”

As advisors know, she continued, “a principles-based standard can serve Main Street investors well. Again, one size does not fit all — this approach would provide valuable flexibility to recognize how customers vary from each other and how the industry may change over time.”

The Reg BI proposal also would seek to preserve “the pay-as-you-go broker-dealer model by recognizing how it differs from the investment advisor model,” Blass said. “This is important because — despite what some clothing labels may tell you — one size does not fit all. Likewise, I would never tell someone that an advisor is always the perfect fit — just as I would never say that about a broker-dealer. The right investment professional depends on the investor’s preferences.”

Another question about Reg BI, Blass said, is how it differs from existing suitability standards for brokers under Financial Industry Regulatory Authority rules.

“Reg BI incorporates but goes beyond suitability, in that it covers disclosure, care and conflict obligations,” Blass said. “The care obligation, for example, would, for the first time, explicitly impose a best-interest standard for recommendations. These obligations are key enhancements that cannot be satisfied by disclosure alone, that place greater emphasis on the importance of costs and financial incentives, and that could be directly enforced by the Commission.”

How does Reg BI compare to existing advice standards?

Reg BI, Blass stated, “draws from principles that apply to investment advice under other regulatory regimes, yet it reflects the structure and characteristics of a broker-dealer’s relationship with retail customers.”

For instance, both Reg BI and the fiduciary duty of investment advisors “require that the firm act in the best interest of the retail customer or investor. The main difference is when each of the obligations will apply. The duties required under Reg BI are tied to each recommendation a broker-dealer makes, whereas an advisor’s fiduciary duty applies to the ongoing relationship with a client,” she said.

Also, she continued, “neither Reg BI nor an advisor’s fiduciary duty explicitly prohibits particular conflicts of interest.”

— Check out Clayton: SEC Broker Conduct Rule Embodies ‘Core Fiduciary Principles’ on ThinkAdvisor.

Melanie Waddell

@Think_MelanieW

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