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Regulation and Compliance > Federal Regulation > FINRA

SEC’s Reg BI Doesn’t ‘Raise the Bar’ Over FINRA’s Suitability Rule: Consumer Groups

By Melanie Waddell

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The Securities and Exchange Commission’s proposed Regulation Best Interest merely codifies the Financial  Industry Regulatory Authority’s suitability rule, and must be revamped in order to truly be a “best interest standard” for brokers, consumer advocacy trade groups told SEC Chairman Jay Clayton on Friday.

“Investors reasonably expect that the investment professionals they turn to for advice will recommend the investments and investment strategies they reasonably believe would best meet the investor’s needs,” the groups – which included Better Markets, the Consumer Federation of America and Consumer Action – told Clayton. “Calling the standard that applies to brokers’ recommendations a ‘best interest’ standard reinforces that reasonable expectation.”

However, the groups state that Reg BI, “as drafted and interpreted in the proposing release, imposes no such obligation. Instead, the Release suggests that the intent of the rulemaking is to codify, rather than enhance, protections investors currently receive under FINRA’s suitability standard, which can be satisfied by recommending any of a potentially large number of ‘suitable’ investments.”

The SEC release explicitly states, “in footnote 7,” the groups write, “that the proposed rule’s information collection requirement, the fact that the duty can’t be satisfied through disclosure alone, and the requirement to make recommendations that are consistent with the customers’ best interests all ‘reflect obligations that already exist under the FINRA suitability rule or have been articulated in related FINRA interpretations and case law.’”

The Commission’s “failure to provide any concrete examples of how Reg BI would raise the bar over FINRA suitability” gives the impression that Reg BI is intended to codify, rather than enhance, the existing suitability standard, the groups write.

Examples in the proposal of how brokers “would be required to weigh a variety of factors and, in particular, how they would be required to consider costs when determining what to recommend, are all consistent with, rather than an enhancement to, FINRA’s interpretation and enforcement of its suitability standard,” the groups state.

The groups sent the letter to Clayton after a recent hour-long meeting.

Robert Colby, FINRA’s chief legal officer, said at an event in late March that as the enforcer of Regulation BI, FINRA will either revamp its current suitability rule once Reg BI is final or eliminate it.

“There’s a lot of overlap between the existing suitability rule and the direction that Reg BI is going in order to mitigate conflicts,” Colby said during a regulatory panel discussion at the Securities Industry and Financial Markets Association’s annual compliance event in Phoenix.

After Reg BI is finalized, FINRA will “look to see first, is there anything different between our [suitability] rule and the way it [Reg BI] comes out? We’ll fix that,” Colby said. “We’ll also look to see if there’s any reason to continue to have a separate suitability rule, because we’ll be enforcing Reg BI and we don’t want to be inconsistent in any way.”

If FINRA decides to keep its suitability rule, “we want to make sure they are completely aligned,” Colby said.

Barbara Roper, director of investor protection for CFA, told ThinkAdvisor on Friday that because FINRA rules exist separate from SEC rules, a potential nixing by FINRA of its suitability rule would “not automatically follow” Reg BI adoption.

“But FINRA has indicated that it will look at updating its rules once the SEC finalizes a rule,” Roper said. “If the SEC were to actually raise the standard, instead of simply codifying the FINRA standard as Reg BI as drafted would do, we would certainly look to FINRA to strengthen its rules as well and to enforce the heightened standard,” she said.

The groups told Clayton that the following changes “are essential” if Reg BI is to qualify as a heightened standard:

  • The Commission must adopt a principles-based definition of best interest that unequivocally raises the bar over the existing suitability standard. In defining the term, it must make clear that brokers are required to recommend the investments they reasonably believe are the best match for the investor from among the reasonably available investment options.
  • If, as has been suggested, one goal is to ensure that brokers give greater consideration to costs in determining what investments to recommend, the rule should incorporate an explicit requirement to consider costs in the rule text. In addition to clarifying the definition of best interest in the actual text of the rule, the Commission must make changes to the rule Release to clarify and strengthen its interpretation of the best interest standard.

Melanie Waddell

@Think_MelanieW

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