The SEC’s new ‘Regulation Best Interest’ standard requires broker-dealers to act in the client’s ‘best interest’ which, it is argued, is a higher standard than the FINRA suitability rule. But critics are not so sure.
There are several opponents lining up to attack the new SEC rule. They generally argue that the rule fails to protect investors while also diluting and undermining the significance of the fiduciary standard.
The SEC’s Regulation Best Interest (often called just ‘Reg BI’) was adopted on 5 June 2019 and will take effect on 30 June 2020. It requires Broker-Dealers to:
- Act in the best interest of the client when making any recommendation of a securities transaction or investment strategy
- Place the customers’ interests ahead of their own interests
In addition to these broad obligations broker-dealers must satisfy four specific obligations:
- Disclosure obligation – full disclosure of fees, charges & costs; limitations on advice and conflicts of interest.
- Care obligation – must exercise reasonable diligence, care and skill to understand the risks, rewards and costs of a recommendation and have a reasonable basis to believe that the recommendation could be in the best interest of ‘at least some customers’. Additional care and competency are required to tailor advice to a specific customer.
- Conflict of interest obligation – identify and disclose or eliminate all conflicts of interest and material limitations associated with recommendations.
- Compliance obligation – establish, maintain, and enforce written policies and procedures to achieve compliance with the overall regulation.
The rules apply to ‘retail customers’ who receive a ‘recommendation’.
A retail customer is a ‘natural person’ who used the recommendation primarily for personal, family or household purposes. High net-worth clients are not excluded, with no presumption of sophistication attached to wealth. This contrasts with FINRA rules, which treat many high net-worth clients as institutional investors.
A new battle over fiduciary standards
Reaction from industry was generally favorable, with some misgivings about the additional compliance costs associated with the new obligations.
But others were quick with their criticism of the new rule.
Their first problem area is the definition of ‘best interest’, which is vague. The second key problem is that some conflicts, such as higher incentives to sell certain products, will not be caught in this rule. Third, they argue that disclosing conflicts is very different to not having them.
The SEC’s on-staff investor advocate, Rick Fleming, recognises this concern, saying the new rule weakens the existing fiduciary standard by suggesting that liability for nearly all conflicts can be avoided through disclosure.
Consumer groups, meanwhile, do not believe the rule is tough enough and share concerns about a blurring of the lines around fiduciary standards which may leave consumers confused. They say this rule will merge best-interest and fiduciary in consumers’ minds, leading them to think they are the same thing when they are different standards.
The SEC adds to the confusion with its new Client Relationship Summary (CRS) form, which compares brokers and advisors side-by-side stating you can get advice from either — essentially making them the same to consumers.