Does Reg BI Mean the Death of Broker-Dealers?

One thing has become clear as we look back on the implementation and enforcement of Regulation Best Interest: It has not only caused a rethinking of what types of products and services advisors want to offer their clients, but also a rethinking of how advisors want to operate.

The Securities and Exchange Commission’s Regulation Best Interest, better known as Reg BI, replaced the broker-dealer suitability standard with an RIA-like fiduciary standard to require that broker-dealers recommend only products that are in their clients’ best interests.

It also requires registered reps to clearly identify any potential conflicts of interest and financial incentives the broker-dealer may have for the sale of those products.

The obligations under Reg BI are fourfold:

• Disclosure Obligation. Registered reps must provide certain required disclosures before or at the time of the recommendation.
• Care Obligation. Registered reps must exercise “reasonable diligence, care and skill in making the recommendation.”
• Conflict of Interest Obligation. Requires broker-dealer firms to “establish, maintain and enforce written policies and procedures reasonably designed to address conflicts of interest.”
• Compliance Obligation. Requires broker-dealer firms to establish, maintain and enforce “written policies and procedures reasonably designed to achieve compliance with Regulation Best Interest.”

What’s Happened So Far

First, it’s important to note that the expected turmoil around the implementation of the rules has not occurred. Opponents of Reg BI feared that there would be a chilling effect across the industry, particularly as enforcement picked up.

I never bought that argument, since most registered reps have operated with the best interests of their clients. Tightening standards is fine for advisors who make the right decisions in their daily work.

Indeed, last year saw the first Reg BI-related enforcement actions by both FINRA and by the SEC. It wasn’t hard to see why the regulators took action.

Both agencies have said more enforcement actions are coming, so it bears watching. But certainly the regulatory sky is not falling. That’s a credit to the industry.

Going Forward

It’s clear, however, that the rule will have a profound effect on advisors in other ways.

When we started Aurora Private Wealth, we also created APW Capital, a full-service broker dealer. We recognized that even though our advisors were committed to giving conflict-free advice we knew that for some clients, transaction-related business was important in products like variable annuities.

Practitioners know that having the widest range of tools at their disposal, whether fee-based or transaction-based, allows them to best fulfill their fiduciary duty to clients.

The issue going forward will be whether advisors eschew transaction-based products in favor of keeping strictly to a fee-based approach.

That would be troublesome, because some products are proper and best for client portfolios, even if the compensation structure for the advisor strays from the standard fee model.

There is still not enough data, for example, to say whether, for many investors, a fee-based model for a product like an annuity is always preferable to commission.

If someone buys an annuity and holds it for a long period of the time, does the advisor really merit an ongoing fee for “managing” that asset?

What about an annuity that has living benefit guarantees in return for limited investment control? Does it make sense to pay fees on an illiquid, nontradeable real estate investment trust (REIT)?

For the client, the best approach may well have been the product commission.

Are BDs in Trouble?

There is no doubt that there is a degree of regulatory safety in being a fee-only advisor. Indeed, even before Reg BI, our industry saw a shift toward the RIA model. In 2010, there were 4,577 FINRA-registered firms, according to data from the agency. In 2020, that number had fallen 25% to 3,435.

Does this spell the death knell for broker-dealers? Certainly not. Most will continue to operate with care in the products they offer. Even if Reg BI makes advisors rethink their product lists, many will still do what’s right for their clients.

Here, proper compliance and meaningful conversations about what is in their clients’ best interests will go a long way toward mitigating any regulatory risk. Do the right thing, and you don’t have to worry about enforcement.

Yet, there will nonetheless be a trend to more fee-based models, and more discussion over whether that RIA model is indeed the best — and safest — path.

It’s important to remember why advisors get into this business. They want to help people build their wealth. How they’re compensated is secondary in their minds.

Yet, how they’re compensated is central to how Reg BI affects them, and that means that this discussion and debate will continue.

(Image: Adobe Stock)

Timothy Smith is chief executive officer of Aurora Private Wealth and its independent broker-dealer, APW Capital Inc.