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The views and opinions expressed in this blog are those of the authors and do not necessarily reflect the official policy or position of SnoQap, any other agency, organization, employer or company. Assumptions made in the analysis are not necessarily reflective of the position of any entity other than the author(s). These views are subject to change and revision.

Regulation Best Interest: Is It in Consumers’ Best Interest?

Regulation Best Interest: Is It in Consumers’ Best Interest?

In a 3-1 vote on Thursday, June 6,  the Securities and Exchange Commission approved Regulation Best Interest, a financial investment reform package aimed at bolstering investor protection by mandating that broker-dealers and financial advisors disclose conflicts of interest.  “Reg BI,” as it has been coined, will force investment professionals and broker-dealers to prioritize the interests of clients above their own personal needs. More specifically, broker-dealers “will be required to act in the best interest of a retail customer when making a recommendation of any securities transaction or investment strategy involving securities to a retail customer.” Before any transaction can be completed, registered broker-dealers and investment advisors must give retail investors a standard disclosure document, which underscores applicable legal standards, the specific services being offered, and the fee structure underlying said services. Furthermore, Regulation Best Interest prohibits the previous quotas that reward brokers who generate the highest sales in certain product areas, as well as sales contests among investment professionals. By the same token, the SEC is focused on eliminating churning, which occurs when a broker conducts excessive trading in a client’s account in order to generate large commissions. Sales contests, such as those held by the discount brokerage firm Scottrade, put agents’ needs ahead of the clients. According to Massachusetts authorities, Scottrade offered its agents thousands of dollars to maintain and grow the firm’s client base.

Current law rules that financial advisors are bound by a fiduciary obligation to clients and must act in their best interest; Regulation Best Interest plans to reinforce this requirement. Although “broker-dealers are generally not subject to a fiduciary duty under the federal securities laws,” courts have concluded that under certain circumstances, they are tied to fiduciary obligations (SEC, 2011). Moreover, broker-dealers are subject to “statutory, Commission, and SRO requirements that are designed to promote business conduct that protects customers from abusive practices” (SEC, 2011). However, opponents of the regulation argue that the financial investment reform package does not specify what a client’s “best interest” is and that the rules are not robust. Many professionals have advocated for a single set of regulations that applies to brokers and financial advisors, necessitating that fiduciaries act in their clients’ best interest at all times. Conversely, Wall Street’s community of advisors has challenged the idea of universal fiduciary regulations, maintaining that it would impede Americans’ ability to receive investment advice and incite a wave of lawsuits. Despite the fact that supporters of the new rule claim that it advances fiduciary code, critics deem it to be diluting legal standard and fueling customer confusion. The rule lacks specific guidance and enforcement policies to hold brokers accountable to these standards.

Regulation Best Interest has it roots in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, which was passed by the Obama administration in response to the 2008 crisis. As a matter of fact, Section 913 of the Dodd-Frank Act authorized the SEC to espouse a best-interest standard of conduct rule and fiduciary obligation for broker-dealers and investment advisors who are sharing “personalized investment advice.” While SEC investment advisors are held to a fiduciary standard, others must abide by a suitability standard, meaning that agents may only sell investments that they believe are suitable for their clients. Both standards play an integral role in the operations of the financial system. Nevertheless, conflict is born from a lack of consumer comprehension between the two different models of advice.

Reg BI has ultimately been packaged into four components. The first is the aforementioned “Regulation Best Interest” piece, which stands at the core of the legislation and requires brokers to act in the “best interest” of clients. The next part of the reform package is the Form CRS, which aims to distinguish between the two models of investment advice and clarify the relationship between the broker or advisor and the client, thus enabling customers to make more informed decisions. According to the SEC’s meeting held on Wednesday, June 5, the Form CRS would need to be given to clients at the start of the relationship with the agent, as to outline the fee and service structure, the legal standard of conduct, and potential conflicts. Additionally, the new rule interprets the standard of conduct regarding those firms that are acting as Registered Investment Advisors (RIA). The SEC published an interpretation of section 202(a)(11)(C) of the Investment Advisers Act of 1940, noting that an “investment advisor” is not  “any broker or dealer that provides advisory services when such services are ‘solely incidental’ to the conduct of the broker or dealer’s business and when such incidental advisory services are provided for no special compensation” (SEC, 2019). These advisors are subsequently not subject to the application of the Advisers Act.

The SEC’s rollout of this final rule is the result of a decade-long conversation. The commission intends to expand and further specify brokers’ role in giving clients investment advice. Although one may deduce that such legislation would breed more stringent regulations for the financial services industry and strengthen consumer protections, this may not be the case. Ironically, “big business and brokers can breathe a sigh of relief…Not only does this rule fail to expand consumer protections and add clarity to the broker vs. advisor roles, it allows brokers to continue business as usual by adding confusion to the market.” While broker-dealers’ obligations are enhanced beyond the previous suitability standard of conduct, the SEC failed to impose a uniform fiduciary standard of care for all advisors. Equally important, passage of this rule served as the ideal time to elucidate the definition of “best interest;” however, the term continues to be up in the air.

Thus far, the legislation is not achieving its intended goals. For instance, the Client Relationship Summary form (CRS), rather than distinguish between investment advisors and brokers, has further diminished customers’ ability to differentiate between the two terms. RAND Corp. conducted a 1,816-people survey on behalf of the SEC, and the results revealed that an estimated 90% of interviewees said that the Form CRS would aid them in making more knowledgeable decisions regarding investment services. 75% claimed that the document improved their comprehension of core conflicts of interest and key terms. Despite these assurances, the qualitative section of the study reported that participants did not fully grasp the content of the Form CRS and were still confused about the differences between financial professionals and account types.

It is feasible that the requirement on the CRS form to say that brokers can also provide investment advice may be perceived as a violation of free speech for a Registered Investment Advisor. The fiduciary may be forced to tell clients this information, when he or she does not believe that a broker can truly provide the same quality of advice. It is feasible that litigation will be filed challenging the SEC from both brokers and investment advisors. Advisors may contend that Regulation Best Interest abolishes the distinction between the two types of financial agents, whereas broker-dealers will likely push for the repealment of regulations. Jay Clayton, Chairman of the SEC, maintains that the reform package ensures that brokers have “very candid” conversations with investors and that it will not impede innovation. So far, it appears that Regulation Best Interest is ironically not in the best interest of retail investors.

Works Cited

U.S. Securities and Exchange Commission. (2019). Commission Interpretation Regarding the

Solely Incidental Prong of the Broke-Dealer Exclusion from the Definition of Investment

Adviser (SEC Publication No. IA-5249). Retrieved from https://www.sec.gov/rules/interp/2019/ia-5249.pdf

U.S. Securities and Exchange Commission. (2011). Study on Investment Advisers and

Broker-Dealers. Retrieved from

https://www.sec.gov/news/studies/2011/913studyfinal.pdf

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