Page turning was in full swing on June 5 as the Securities and Exchange Commission rubber-stamped Regulation Best Interest for brokers and the agency’s advice-standards package — which combined totaled around 1,000 pages.
The final Reg BI came in at approximately 771 pages, taking up the bulk of the four-pronged plan. Industry officials contacted said they were, naturally, still combing through the package, but nonetheless had some initial thoughts to share.
All four prongs of the advice-standards package — Reg BI, the Form CRS Relationship Summary, the Standard of Conduct for Investment Advisers, and a new Interpretation of “Solely Incidental” — passed by a 3-1 vote, with SEC Commissioner Robert Jackson, a Democrat, dissenting on all parts.
Jackson stated that his hope was that the final rules would leave “no doubt that investors come first. Sadly, I cannot say that. Today’s rules maintain a muddled standard. Today’s rules simply do not require that investors’ interests come first.”
Jackson stated that he couldn’t vote for any of the four prongs of the plan, as neither Reg BI nor the advisor recommendations “requires Wall Street to put investors’ interest first.” SEC Commissioner Hester Peirce, a Republican, noted the “aggressive” compliance date of June 30, 2020. She also said that while the highly-criticized Form CRS has been improved, more work needs to be done.
In his opening remarks at the June 5 open meeting, SEC Chairman Jay Clayton argued that the standard of conduct action “is long overdue. The fact that it is overdue does not make it easier. I believe the delay has made it more difficult as many interested parties have developed strident and divergent views on the state of the market, as well as current law and regulation, and what should be done to better serve the interests of our Main Street investors.”
Clayton said that Reg BI “will substantially enhance the broker-dealer standard of conduct beyond existing suitability obligations, requiring broker-dealers, among other things, to act in the best interest of their retail customers when making a recommendation, including not placing their financial or other interests ahead of the interests of the retail customer.” Reg BI also requires the following:
Disclosure obligation: Broker-dealers must disclose material facts about the relationship and recommendations, including specific disclosures about the capacity in which the broker is acting, fees, the type and scope of services provided, conflicts, limitations on services and products, and whether the broker-dealer provides monitoring services.
Care obligation: The broker-dealer must establish, maintain and enforce written policies and procedures reasonably designed to identify and at a minimum disclose or eliminate conflicts of interest. The obligation, an enhancement from the proposal, specifically requires policies and procedures to:
• Mitigate conflicts that create an incentive for the firm’s financial professionals to place their interest or the interests of the firm ahead of the retail customer’s interest; •Prevent material limitations on offerings, such as limited product menu offering only proprietary products, from causing the firm or its financial professionals to place his or her interest or interests of the firm ahead of the retail customer’s interest; and • Eliminate sales contests, sales quotas, bonuses and non-cash compensation that are based on the sale of specific securities or specific types of securities within a limited period of time.
Compliance obligation: A new requirement from the proposal, broker-dealers must establish, maintain and enforce policies and procedures reasonably designed to achieve compliance with Reg BI.
Blaine Aikin, executive chairman at Fi360 in Pittsburgh, a fiduciary education, training and technology company, told me at press time that Reg BI “does raise the suitability standard a bit higher than it is today for broker-dealers.”
That said, however, Aikin sees the entire advice package as weakening investor protections. Reg BI “cannot be considered in isolation; the other three parts of the regulatory package are intertwined with Reg BI. Taken together, the package must be viewed as a setback for investor protection and for the profession of investment advice,” he said.
The package, Aikin continued, “does not clearly delineate best interest, rather it obfuscates the fundamental differences between fiduciary advice and sales recommendations.”
Bottom line according to Aikin: the package “will add to investor confusion, exacerbate the problem of low public trust in financial services and add to tensions across the multiple factions that have formed over the lack of clear and client-centric regulations for all who provide advice: Wall Street versus Main Street, brokers versus advisors, and Republican versus Democrat legislators.”
The June 30, 2020, compliance date will “arrive quickly,” Aikin said, and “firms will be challenged to interpret the regulations, tailor business practices to be both compliant and competitive, and deliver training to advisors.”
Reg BI is “a mixed bag” said Barbara Roper, director of investor protection for the Consumer Federation of America. The SEC, she said, “made some tweaks to the rule that move it in the right direction — in particular by including the prohibition on placing the broker’s interest ahead of the customer’s interest in the rule’s compliance safe harbor — but that’s more than outweighed by their weakening of the conflict provisions, where conflicts now only have to be mitigated at the individual level, and firm-level conflicts are addressed exclusively through disclosure.”
Similarly, she added, “the gain in Reg BI on account monitoring is more than outweighed by the adoption of a new interpretation of brokers’ solely incidental to exemption that gives brokers virtually unlimited ability to market themselves as trusted advisors, and lure investors into thinking they are in long-term relationships of trust and confidence, without appropriately regulating those relationships.”
Ken Bentsen, president and CEO of the Securities Industry and Financial Markets Association, said “as written,” Reg BI “will impose a materially heightened standard of conduct for broker-dealers when serving retail clients.” However, Bentsen conceded that “compliance with the rule will not be easy for the industry. Firms will need to make substantial changes. The costs to implement will no doubt be significant,” he said, but “worthwhile.”
Larry Stadulis, a partner at Stradley Ronon in Washington, said that instead of full-on title reform — that is, the SEC’s original plan to block brokers from using the terms “adviser/advisor” or other titles like wealth manager — the securities regulator instead took an interpretive approach.
“One of the requirements of Reg BI is that advisors disclose to customers prior to a recommendation the capacity in which they’re acting. And the capacity is acting as either broker-dealer, or if they’re a dual registrant, broker-dealer/investment advisor,” Stadulis explained.
“If you say in your [Form] CRS that you’re acting as a broker, but in [advertising] material the person is being referred to as an advisor, that’s a breach of capacity provision; that violates the disclosure of capacity requirement,” Stadulis said.
In other words, he added, “in your disclosures under Reg BI you have to disclose your ‘capacity.’ If you say you’re a broker but you’re using the term advisor or investment advisor elsewhere, that would violate the capacity disclosure requirement.”
He notes that the SEC’s final rules states that the Financial Industry Regulatory Authority “will be looking at marketing materials to see if they’re misleading because of titles.”
FINRA, which will enforce Reg BI, said that “in the coming months, we will be assessing how to conform our rules and examination programs to Reg BI.”
Both Stadulis and Aikin see potential lawsuits challenging Reg BI on the horizon, likely lobbed by trade groups or the states.
As Stadulis noted, Reg BI “does not set out whether it preempts state law.”
Further, “the SEC says in the [final] release that they do not address preemption issues because that will be done by the courts,” Stadulis said, noting that the SEC’s phrasing indicates the securities regulator is expecting lawsuits.
Washington Bureau Chief Melanie Waddell can be reached at firstname.lastname@example.org.