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Sales Practice Risk in the Digital Era, Part 1: Where We Are, Where We're Going

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Recent tightening of rules to protect investors and prevent sales misconduct at U.S. retail banks, brokerages and registered investment advisors have increased hurdles for businesses in the wealth management sector. Under new requirements, firms across the board continue to overhaul their approach to selling products and services, managing related risks, deploying appropriate controls, and restructuring employee remuneration and commissions.

When it comes to the provision of investment advice, innovation in financial products and services is a two-edged sword. Purely online offerings such as automated investment portfolios (i.e., robo-advisors) have been shown to increase the likelihood that an investor will use products without fully understanding the potential risks and investment options. In turn, these firms are exposed to additional legal, regulatory and reputational risks that they have yet to determine how to mitigate. One example is regulators’ increasing focus on the intersection of automated investment advice with the broad array of selling practice rules, including suitability, fiduciary standards, mis-selling, conflicts of interest, fund bias and ethical misconduct.

It is imperative that firms serving the retail, affluent and high-net-worth client segments examine the evolving risks associated with selling practices, particularly those that are increasingly impacted by technology. This would not only apply to brokerage services or the provision of investment advice but also at the enterprise level with regard to referrals to strategic partners and adjacent business lines. By assessing these risks, firms will better position themselves to meet the evolving requirements of automated offerings while getting ahead of heightened standards expected in the third quarter of 2019, in the form of both a best-interest standard from the Securities and Exchange Commission and in a revised Department of Labor fiduciary rule.

Recent Regulatory Developments in the Provision of Investment Advice

Fiduciary Standards

There is currently confusion in the retail and wealth management investment sectors over the standards to which an investment professional is bound, both legally and ethically. The DOL’s fiduciary rule, proposed in 2016, aimed to expand the applicability of the “investment advice fiduciary” standard to cover all financial professionals who advise on retirement assets in “qualified accounts” or provide any form of retirement planning advice. This would have obliged these professionals to provide advice in the client’s best interest and not advice only identified as “suitable” to their needs.

Under the Trump administration, Labor stepped back from the rule, and it was later vacated by the U.S. 5th Circuit Court of Appeals. The industry is believed to have spent several billion dollars in anticipation of the rule, making significant changes to business models, products, pricing and advisor compensation in order to comply with its standards. More recently the department has stated that it is now working toward a revised rule, which is expected to be issued by the third quarter of 2019.

Although the DOL rule was ultimately overturned, the SEC still sought to strengthen consumer protection and was given authority to act in its capacity as a regulator via the Dodd-Frank Act. In 2018, the commission proposed two pending rules: Regulation Best Interest (Reg BI) and the Form CRS Relationship Summary rule.

The SEC’s proposed Reg BI says that “A [broker-dealer (BD)], when making a recommendation of a securities transaction or investment strategy to a retail customer, will be required to act in the best interest of that customer at the time the recommendation is made, without placing the financial or other interest of the BD ahead of the interest of the retail customer. This best interest duty is discharged if the BD complies with a disclosure obligation, a care obligation, and two conflict of interest obligations.”

The key difference between a fiduciary and a best-interest standard is that the fiduciary relationship creates a legally binding obligation in which the pecuniary or other interest of the firm or associated member of that firm must be subordinate to the interest of the client. At the heart of the fiduciary and best-interest standards lies a focus on conflicts of interest, disclosure of said conflicts of interests, and the concept of putting the client’s interest ahead of the firm’s.

The CRS rule would have two “clear labeling” components. Broker-dealers and investment advisors would have to be “direct and clear about their legal form in communications with investors and prospective investors.” Broker-dealers would also be restricted from calling themselves “advisors,” which might mislead prospective customers into thinking that they are registered investment advisers.

As the SEC proceeds toward finalizing Reg BI by September, possibly in tandem with the revised DOL rule, retail brokerages and wealth managers will need to stay abreast of developments to ensure that they are well positioned to meet the new and heightened standards. Although the initial DOL rule was overturned, its underlying principles set forth a fundamental and lasting shift in the industry that is likely a harbinger of what is still to come. Impending SEC regulations will continue the momentum of increased focus on a uniform fiduciary standard; however, details of such rules are expected to be more principles-based and less prescriptive than those required under the original DOL rule.

To add to the complexity of overlapping oversight at the federal level, several individual states have sought to draft legislation of their own to create fiduciary standards, often predicated on politics within the local governing bodies. Notably, New Jersey released a pre-proposal in October 2018 that would require broker-dealers, agents, RIAs and representatives to abide by a uniform fiduciary duty. In Maryland, a proposed consumer protection bill would make broker-dealers, broker-dealer agents and insurance producers fiduciaries. If such legislation is passed, it only stands to further muddy the waters for both firms and investors.

Automated Investment Solutions and Tools

Firms must keep mind that all of this applies to automated advice as well, as such firms must both position for heightened standards and close existing gaps with automated solutions that have increasing regulatory focus.

While proposed rules have not sought to target robo-advisors directly, the SEC has issued guidance to firms, emphasizing that automated offerings would still be subject to the fiduciary and substantive requirements of the Advisers Act. The SEC guidance also highlighted general concerns on automated offerings, specifically surrounding suitability determinations, level of disclosures (e.g., on underlying algorithms, fees, projections), cybersecurity, and referral programs. Similarly, the Financial Industry Regulatory Authority has also provided guidance, focusing on areas such as governance, supervision, investor profiling and education.

Looking abroad, the European Securities and Markets Authority (ESMA) recently published guidelines of its own, stressing the importance of providing clients with a clear explanation of how suitability assessments are conducted and a description of the underlying factors determining investment advice under a robo-advisor. Further, ESMA strongly encouraged firms to provide clients with a clear explanation of the robo-advisory relationship, including ways in which a client can seek human assistance.

As the rules governing the automated solution landscape continue to be defined, it will be imperative for firms to review their existing risk and compliance frameworks in order to meet the anticipated needs ahead.

Part 2 of our series will address the risks posed by these regulatory developments and how best to mitigate them.

Greg Soueid, TreliantGregory K. Soueid is a managing director with Treliant and is head of the firm’s wealth management service area. He can be reached at [email protected].

Lynn Woosley, TreliantLynn W. Woosley is an engagement director with Treliant and is a seasoned executive with extensive experience in regulatory compliance and risk management. She can be reached at [email protected].

Dom Mangonon, TreliantDominic A. Mangonon is a senior consultant with Treliant within the firm’s Wealth Management service area. He can be reached at [email protected].


Additional Treliant contributions from Max Sherman.


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