On June 5, 2019, the Securities and Exchange Commission (SEC) held a meeting that had four specific items to decide. In the meeting, the SEC approved a debated proposal called Regulation Best Interest (Reg BI), holding financial advisors to the best interest standard. Not only did the SEC discuss and approve Reg BI for financial advisors and retail (non-institutional) investors, but they discussed and closed certain loophole definitions as well.ThinkAdvisor quotes Chairman Jay Clayton, “This action is long overdue; the fact that it is overdue doesn’t make it easier. Delay has made it more difficult.”
Although the SEC had four items on the docket for discussion, the headline item has been of particular interest for a while. The SEC held a vote on whether to adopt Reg BI, which proposed to establish a standard of conduct for any persons who are in the role of making recommendations to a customer regarding any securities or investment strategy transaction.
Often considered the SEC's version of the DOL's contested and currently defunct Fiduciary Rule, Reg BI sets a new standard of conduct for broker-dealers and other individuals in investment advisory roles. Essentially, the regulation requires such persons to consider the customer's best interests ahead of any financial or other type of gain for the advisor.
In addition to a "best interest" standard, brokers will be required to provide extensive disclosures regarding facts about investment advice, including potential and material conflicts of interest. Investment News highlights how Clayton emphasized the transparency of Reg BI, “No existing disclosures provide the kind of transparency and comparability that the relationship summary will provide.” Advisors will be required to maintain procedures and policies designed to eliminate or mitigate conflicts of interest. Under its conflict of interest obligations, Reg BI will eliminate sales contests, sales quotas, bonuses and non-cash compensation that are based on the sale of specific securities in a period of time.
While proponents have often said Reg BI will close certain loopholes, detractors have stated this does not go far enough beyond the current suitability standard that states an advisor must make sure an investment recommendation is suitable for the client's needs. Unlike the DOL's Fiduciary Rule, there is no tracking of the regulation, which may allow unscrupulous advisors to continue business as usual.
With a 3-1 vote, the SEC has voted to implement Reg BI into practice. Though there is no set timeline or structure regarding implementation, it is suggested that firms comply immediately.There will soon be effective and enforcement dates published that will define when firms will need to comply with the rule. Reg BI will be closely monitored during the implementation process to see if it is properly calibrated.
Two other items were voted upon and approved to accompany Reg BI. The commission voted to implement rules and forms requiring Registered Investment Advisors (RIAs) and broker-dealers to provide a brief client relationship summary (Form CRS) to retail investors.
Form CRS would require all broker-dealers, RIAs and dual registrants to provide a form describing in plain language the firm's relationships and services it provides to customers, including accounts offered. Included in the form would be a summary of fees and costs that a retail investor would incur by working with the firm.
In addition to a few other items, Form CRS would prohibit broker-dealers from using "advisor" as part of its name when communicating with retail customers. Also, the commission voted to publish an interpretation of the existing standard of conduct for RIAs.
The last item the commission decided upon was whether to publish an interpretation of the incidental prong of Section 202(a)(11)(c) of the Investment Advisors Act of 1940. This incidental advice provision has long been a loophole that has allowed questionable advice of ill-defined quantity, type and substance without requiring a broker-dealer to register with the SEC as an investment advisor.
Some have argued this loophole has been a main source of confusion between non-fiduciary and fiduciary standards of conduct that apply to advice from broker-dealers and RIAs, respectively. The SEC voting to publish an interpretation will help establish clearer guidelines.
Despite the commission voting in favor of the above measures, there will be a long and complicated process regarding releases. The SEC will be required to provide more clarity around what the "best interest" standard means, as well as how different investment entities are to implement the regulation. Proposed changes in the final version compared to the original will capture industry attention as different interest groups weigh in and analyze what is required by the regulation.
Likewise, we can expect Form CRS to continue to come under heavy scrutiny, as brokers have strongly opposed the prohibition of the terms "advisor" or "adviser." One thing to watch for on the final form is if it will hold to the requirement that brokers provide investment advisory practices information.
Ultimately, the passage of Reg BI and the supporting interpretations and forms will benefit retail investors and clear up confusion regarding different terms, commissions and fees assigned. There will be a long road ahead of defining and interpretation, however, and we might see a bit of litigation before it's over.
Securities and Advisory services offered through LPL Financial, a registered investment advisor. Member FINRA/SIPC.
This information is not intended as authoritative guidance or tax or legal advice. You should consult your attorney or tax advisor for guidance on your specific situation.
Brian Menickella is a co-founder and managing partner of The Beacon Group of Companies, a broad-based financial services firm based in King of Prussia, Pa.
