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3 Ways SEC Reg BI Could Confuse Investors: Reish

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The Securities and Exchange Commission’s proposed Regulation Best Interest, or Reg BI, for brokers differs from the best-interest standard for advisors in three “significant” ways, which could lead to investor confusion, says prominent ERISA attorney Fred Reish.

If the securities regulator’s proposed package of advice standards rules become final, “both broker-dealers and investment advisors will be able to say that they are subject to a best-interest standard of care and duty of loyalty,” explains Reish, partner in Drinker Biddle & Reath’s Los Angeles office, in a recent white paper he wrote for TD Ameritrade Institutional on the SEC’s three-pronged proposal.

(Related: SEC Nominee Roisman Would Keep ‘Open Mind’ on Best-Interest Rule)

“On the surface, those statements will be accurate, but will sound as if the standards are the same,” Reish states.

Here’s how Reish describes what he sees as “meaningful” differences:

1. Reg BI for broker-dealers applies only to recommendations of securities transactions or investment strategies involving securities transactions. For example, it does not apply to recommendations of account types, unless accompanied by a securities recommendation. However, all recommendations made by investment advisors are subject to the best-interest standard.

2. Reg BI for broker-dealers only applies to recommendations to “retail customers.” A retail customer is defined as a natural person, or the legal representative of a natural person (for example, a personal trust or an IRA), who uses the recommendation primarily for personal, family, or household purposes. That would exclude, for example, advice to charities, businesses and retirement plans. The RIA best-interest standard applies to all of the advisor’s clients.

3. Reg BI for broker-dealers would only apply at the time the recommendation is made. That means that there would not be a legal duty for broker-dealers to monitor the investment recommendations and accounts of their customers. Investment advisors have a duty of care to monitor their investment recommendations and accounts at appropriate intervals, unless they contract to limit that responsibility.

“The differences, and their consequences, only become clear when the scope of the duties is understood,” Reish states. “As a result, these rules have the potential to create confusion and misunderstanding in the marketplace.”

The saving grace to help remedy potential investor confusion, however, is the disclosure in the SEC’s proposed Form CRS Relationship summaries, Reish adds.

But as Reish points out, the SEC and other investor organizations are currently conducting testing to determine if investors understand the information in the CRS forms.

(Related: ‘Raise Your Voice’ Campaign Pushes for SEC Reg BI Changes)

The SEC’s proposed guidance on the Form CRS relationship summaries “is lengthy (over 150 pages of fine print), and the SEC asks for answers to over 200 questions.”

The investor testing results could mean the CRS forms “will be revised and reissued for comments,” Reish opines, and he encourages advisors to, “at the least, review the Form CRS proposed for RIAs, together with the instructions, and decide whether to comment on those.”

The comment period on the SEC’s advice standards package expires Aug. 7.

Consumer groups that asked the SEC to extend the Aug. 7 comment deadline for the regulator’s “sweeping” Reg BI and Form CRS to allow enough time to test the new disclosures on investors and report the results have yet to hear back from the agency, Barbara Roper, director of investor protection for the Consumer Federation of America, told ThinkAdvisor on Tuesday.

The groups asking the agency for an extension include the consumer federation, the CFA Institute, the Certified Financial Planner Board of Standards, The Committee for the Fiduciary Standard, Consumer Action and the Financial Planning Association.

“We’re operating on the expectation that the comment period will close next Tuesday, as planned,” Roper said. “Assuming we’re right, the question remains whether they [the SEC] will provide an additional opportunity for public comment once they make the testing results public (assuming, of course, that they do).”

State Action and the Regulatory Landscape

Further actions by the states in promulgating rules in the fiduciary/best-interest realm could also further “conflict” with SEC and state rules, said Drinker Biddle partner Brad Campbell in the law firm’s recent Inside the Beltway webcast.

Campbell, former head of the Labor Department’s Employee Benefits Security Administration, pointed to New York’s recently finalized best-interest standards for life insurance and annuities.

The New York rules will go into effect for annuities in August 2019 and for life insurance in February 2020, Campbell said. “We’re probably going to hear a lot more about New York and where it’s going there” with those rules, specifically questions “resulting from both the way New York promulgated the rule as well as some of the issues it raises.”

Campbell sees “built-in tension” with the New York best-interest rule in that while it “preserves all forms of compensation, … it says but only to the extent [the compensation doesn't] influence best interest. That’s going to introduce a big notice of ambiguity about what compensation is appropriate, what is influencing best interest and what isn’t,” which is “somewhat akin to this mitigation debate that we have” with the SEC Reg BI proposal.

While Nevada’s legislature has passed its own fiduciary rule for securities, the state insurance regulator is developing a new best-interest standard for annuities that could be out by next month, Campbell relayed.

“Other states have been debating standards but haven’t really acted yet,” he said. “That’s one of things that will be interesting to see over the next year is how many states move forward — prime examples might be California, Illinois, New Jersey.”

How will the states “further complicate the regulatory landscape?” Campbell said. “For example, a registered reps who’s also an insurance agent who’s selling an annuity into an IRA — that’s a scenario where we’re going to see a lot of overlapping regulatory regimes.”

Added Campbell: “Having rules that fit well together is going to be an increasing challenge as we go forward.”