New SEC Guidance Tackles How to Handle Conflicts of Interest

New guidance from the Securities and Exchange Commission warns firms that identifying and addressing conflicts under Regulation Best Interest and the Advisers Act fiduciary standard “should not be merely a ‘check-the-box’ exercise, but a robust, ongoing process that is tailored to each conflict.”

In its new guidance, released Wednesday morning in Q&A form, SEC staff notes that it’s “important that firms and their financial professionals review their business models and relationships with investors to address conflicts of interest specific to them.”

Industry sources I contacted see the bulletin as helping brokers and advisors figure out “how” to identify and address conflicts.

This is the second set of Reg BI-related guidance issued by the Commission. The first was released in March and addressed account recommendations — such as rollovers.

The agency expects to release further guidance on broker and advisor care obligations, which would include consideration of reasonably available alternatives as well as costs and risks.

“This is one of the first substantive pieces of guidance on Reg BI for the brokerage industry and the fiduciary standard for investment advisers” under SEC Chairman Gary Gensler, Jim Lundy, a partner and member of the Securities Enforcement & Litigation Practice at Foley & Lardner LLP, said in an email. “As such, brokerage and investment advisory firms should give this a close study and apply it to their business model and compliance and supervision programs as they best see fit to do so.”

The FAQ, Lundy added, “may be viewed as helpful in that it provides much greater detail and guidance for the ‘how’ aspect of getting into and maintaining compliance with these standards.”

Micah Hauptman, director of investor protection for the Consumer Federation of America, agreed in another email that the guidance “will be helpful to firms and financial professionals as they consider how best to address different conflicts in their business models.”

The guidance, Hauptman said, “is consistent with what Chair Gensler has promised, to provide additional clarity about what Reg BI and the Advisers Act fiduciary duty require and to make the most out of them. We welcome it.”

The bulletin “makes clear that firms should not approach conflicts of interest as a ‘box-checking’ exercise and that how firms address various conflicts will depend on the nature and extent of those conflicts,” Hauptman added.

Further, he continued, “it makes clear that there are some conflicts that are of a nature and extent that firms would be unable to address in a way that would allow the firm or its financial professionals to provide advice or recommendations that are in the retail investor’s best interest. In those cases, firms would need to take much more aggressive action in addressing those conflicts, including eliminating them or refraining from providing advice or recommendations that could be influenced by the conflicts to avoid violating the obligation to act in the retail investor’s best interest.”

‘Conflation’ of Reg BI and Fiduciary Standard?

The guidance “seems designed to point out the similarities between Reg BI and the fiduciary standard rather than to point out the differences,” Nicolas Morgan, a partner at Paul Hastings, said in another email.

“The fact that the guidance is coming out for both Reg BI and the fiduciary standard for investment advisers in one bulletin for both is indicative of the continuing conflation of these two standards that we have been seeing for the past few years,” Lundy added. “We are still not at a universal fiduciary standard, but it would not be a surprise for the Division of Examinations and the Division of Enforcement under this regime to continue to push these standards closer to alignment.”

While the guidance addresses conflicts under Reg BI and the fiduciary standard, Hauptman adds: “They still differ in scope and application. But both standards stem from key fiduciary principles.”

The guidance fails to address, however, “what aspects of conflict mitigation required for IAs under the fiduciary standard are not required for BDs under Reg BI,” Morgan maintains.

“In other words, for investors who want a low-cost option and are not concerned about conflict issues, does Reg BI permit investors and BDs to agree to a ‘pure brokerage’ model under which the broker has minimal obligations to mitigate potential conflict risks?”

Key Takeaways

The guidance points out that there are no conflict-free business models. While all firms have some conflicts, the nature and extent can vary greatly from firm to firm based on business model or product mix.

Addressing conflicts is also not a set-it-and-forget-it task. The steps to address conflicts need to be tailored to a firm’s particular business model.

The guidance also provides steps firms can take to “identify” conflicts.

Disclosure Is Not Enough

Have firms that have identified all of their conflicts of interest and disclosed them to retail investors satisfied their obligations under Reg BI and the IA fiduciary standard?

No, according to the guidance.

“Disclosure of conflicts alone does not satisfy the obligation to act in a retail investor’s best interest. Further, … certain conflicts should (and in some cases, must) be addressed through mitigation. Where such conflicts cannot be effectively addressed through mitigation, firms may need to determine whether to eliminate the conflict or refrain from providing advice or recommendations that are influenced by that conflict to avoid violating the obligation to act in a retail investor’s best interest in light of the investor’s objectives.”

Even if conflicts are sufficiently addressed, the guidance continues, “under both Reg BI and the IA fiduciary standard, firms and their financial professionals can provide recommendations or advice only when they have a reasonable basis to believe that the recommendation or advice is in the retail investor’s best interest.”