Regulation Best Interest (Regulation BI)

The SEC recently passed the much-debated Regulation Best Interest, which is the SEC version of the DOL fiduciary rule (which has been vacated entirely by the 5thCircuit in the time since its controversial enactment). Regulation BI, as the rule is known, establishes a standard of conduct that investment advisors and broker-dealers must adhere to in their dealings with retail investment customers. The rule applies to a variety of transactions involving securities, and was also expanded to include rollover transactions that involve recommendations with respect to potential securities transactions. In general, the rule requires that the advisor have a reasonable basis for believing that the rollover is in the client’s best interest before making the recommendation and that certain conflicts and compensation structures be disclosed to clients.

We asked two professors and authors of ALM’s Tax Facts with opposing political viewpoints to share their opinions about the newly released rule and its potential impact.

Their Votes:

Byrnes

Bloink

Their Reasons:

Below is a summary of the debate that ensued between the two professors.

Byrnes: Regulation BI will undoubtedly create substantial compliance challenges for broker-dealers and others who become subject to the rule, including the firms for which they work. Despite this, it was obvious that we needed to enact some sort of rule to ensure that investors are protected when relying upon the advice of a trusted advisor. This rule accomplishes that without creating some of the more severe hardships that would have arisen under the old DOL fiduciary rule, so I think we’re on the right track.

Bloink: Regulation BI is a shell of the old fiduciary rule—meaning that the rule doesn’t go nearly far enough to establish adequate safeguards for retail investors. We’re talking about individual clients who may rely entirely upon the advice of their advisor in making all financial decisions. They place their hard-earned savings in the hands of the advisor, who should be held to the highest duty of care when it comes to protecting those assets.

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Byrnes: This package of legislation significantly heightens the duty of care that broker-dealers will now owe to their clients. These professionals will be required to act in their clients’ best interests, which is a clear standard and exactly what we’ve wanted all along.

Bloink: Unfortunately, Regulation BI is unlikely to accomplish the goal of providing clear and unambiguous protections for investors. The package of rules might be hundreds of pages long, but it fails to prohibit conflicts of interests in any real manner. For example, the client can consent to the conflict based upon the advisor’s disclosure in a document that might be entirely too complicated for the typical retail investor to even understand. Further, will the client even read the document that contains the disclosure before “consenting”? Why not prohibit broker-dealers from providing conflicted advice that might harm the client in the first place?

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Byrnes: The rule mandates certain disclosures that must be made to the client—meaning that conflicts must be clearly disclosed. The broker must also disclose his or her compensation structure to the client, so that conflicts cannot be hidden. This regulation ensures that all investors will have access to the trusted financial advice that they need to make important decisions regarding their financial future.

Bloink: The rule doesn’t even clearly delineate who will be subject to the new “best interest” standard—broker-dealers and registered advisors, sure, but what about the myriad of advisors out there who won’t technically be regulated by this rule, but hold themselves out as advisors to clients? At worst, this “Regulation Best Interest” will lull investors into a false sense of security over the duty owed to them by their financial advisor—many will believe that because the advisor must disclose compensation practices and potential conflicts, that the advisor will not provide conflicted advice. The rule potentially opens the door for advisors to provide harmful and conflicted advice to clients while simultaneously obtaining the SEC’s blessing because they’ve “disclosed” the conflict in some sort of documentation.