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Industry Spotlight > Broker Dealers

Trendspotter: Why Reg BI Will Push More BDs Into RIA Model

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The Trend:

Broker-dealers’ shift to the independent registered investment advisor model will accelerate due to compliance with the Securities and Exchange Commission’s Regulation Best Interest.

The Driver:

While BDs’ shift to the fee-based model has been happening for years due to consolidation and technology trends, compliance costs associated with Reg BI are likely to accelerate the move. Securities and Exchange Commission Chairman Gary Gensler’s recent comments about enforcing Reg BI to the letter signal that he’s serious about enforcing the rule.

(As of year-end 2019, 3,517 broker-dealer firms were registered with the Financial Industry Regulatory Authority, 90 fewer firms than were registered with the broker-dealer self-regulator in 2018.)

We’re interested to hear from you. How do you see the SEC’s Regulation Best Interest reshaping the advisory business? Let me know what trends you’re spotting this week at [email protected]

The Buzz:

Barbara Roper, director of investor protection, Consumer Federation of America

Reg BI is written to include a best-interest standard and mitigation of conflicts. If the SEC were to start enforcing those obligations in a meaningful way, that could lead to significant changes in industry practices. And if the Commission finds that it is not changing industry practices as intended, [Gensler's] comment seems to suggest that they will act on that. Realistically, the Commission was never going to revise the rule without evidence that changes are needed, so [SEC Chairman Gary Gensler’s recent comments that he will enforce Reg BI to the letter and the agency will evaluate the rule] strikes me as an appropriate approach.

One of our concerns with Reg BI when it was adopted was that it used terms like “best interest” and “mitigation of conflicts” but it didn’t really mean them. What Chair Gensler has said is that he means them, and that could lead to a whole different approach to implementation and enforcement, in my opinion.

[As for Reg BI compliance] driving more BDs to the RIA model, this is one reason CFA has also emphasized the importance of strengthening the Advisers Act fiduciary guidance along similar lines.

For too long, advisers’ fiduciary obligation to act in clients’ best interest hasn’t been enforced. And the recent growth of fee accounts at dual registrant firms has introduced some troubling new conflicts. The traditional approach to enforcing the Advisers Act standard, which is heavily reliant on disclosure to address conflicts, isn’t adequate as the conflicts become more complex and opaque.

Under the Advisers Act, there is an assumption that disclosure in the ADV form regarding conflicts or other potentially harmful practices leads to “informed consent” on the part of the investor. So, if they go ahead and engage the adviser, they are presumed to have given informed consent to those conflicts and potentially harmful practices. But the disclosures are long, dense and incomprehensible to the typical investor, making this whole regulatory approach suspect in my view. That’s one reason we’ve called on the SEC to test the disclosures, including the ADV Form, to see if they are fulfilling their regulatory function.

Amy Lynch, Founder and President, FrontLine Compliance

The move to switch from a BD commission-based model to a fee-based RIA model has been happening for many years now. This trend started when commissions started coming down due to enhanced electronic trading systems (Alts) which began in the late 90s. … However, Reg BI has certainly given the brokerage industry yet another reason to move to a fee-based model where revenue streams have not been squeezed quite so much.

The fee-based model has also seen a reduction in fees for some of the same reasons as the BD industry (the advent of technology systems for portfolio management, etc.). The cost of managing portfolios has come down and will continue to do so as the human element is replaced by technology. Reg BI simply levels the playing field a bit by putting more responsibility on the BD for customer and transaction due diligence and care in a manner that is more similar to a fee-based model.

Linda Shirkey, Bates Compliance Managing Director, Bates Group

I think there are a couple of trends happening. The average age of founding members of smaller RIAs is 70, so there is a lot of consolidation happening on the RIA front with aggregators acquiring many small to medium-sized firms.

On the other hand, we are seeing more broker-dealers becoming dual registrants, partly for the smoother revenue stream, and possibly as a result of the increased compliance requirements to meet Reg BI. It is clear that the broker-dealer numbers continue to shrink, but this was occurring long before Reg BI became effective. That may merely accelerate the shrinkage.

Jason Ewasko, Managing Director at Cipperman Compliance Services

Based on what we’ve been seeing in the compliance outsourcing marketplace over the past several years, there’s been a gradual push away from the broker-dealer business model toward the registered investment adviser model.

Realistically, Reg BI and all of the regulatory, operational and disclosure-related red tape that comes along with it is likely to help accelerate that movement. That being said, it’s worth noting that RIAs providing advisory services to retail investors are required to have in place Form CRS (as required by Reg BI), so it’s not as if RIAs are completely immune, but Reg BI inherently has less of an impact on registered advisers’ businesses given their existing fiduciary obligations and disclosure requirements.

Ultimately, there may not be much legal daylight between a Best Interest Standard and the Fiduciary Standard, especially if the SEC takes a strict enforcement approach, as new Chair Gensler has suggested. Regardless, given current market trends and the impact of Reg BI, we expect to continue to see greater adoption of the RIA model.


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