On June 5th of 2019, the SEC issued its final version of Regulation Best Interest, which will require brokers and their broker-dealers to act in their clients’ best interests when making an investment recommendation, by meeting four core obligations: Disclosure (providing certain prescribed disclosure before or at the time of recommendation, about the recommendation and the relationship between the retail customer and the broker-dealer); Care (exercising reasonable diligence, care, and skill in making the recommendation); Conflicts of Interest (establishing, maintaining, and enforcing policies and procedures reasonably designed to address conflicts of interest); and Compliance (establishing, maintaining, and enforcing policies and procedures reasonably designed to achieve compliance with Regulation Best Interest).
In addition to Regulation Best Interest itself, the SEC is also implementing a newly required “Form CRS” (Customer/Client Relationship Summary) that both broker-dealers and RIAs will be obligated to provide their prospects, to further explain the nature of their services and relationship, their fees and costs, and their standard of conduct and conflicts of interest. Which will provide both new light on the business practices of broker-dealers – by requiring them to disclose upfront if they are using proprietary products, or receiving revenue-sharing or other behind-the-scenes payments – but also require new disclosures of RIAs (e.g., to state upfront their asset/account minimums, and to disclose how their own advisors are compensated and any advisor-level conflicts of interest that may be present as a result).
As a part of its Regulation Best Interest and Form CRS rulemaking, the SEC also issued updated interpretations of an RIA’s fiduciary obligations (a Duty of Care to provide best-interests advice, seek best execution, and provide ongoing monitoring when agreed upon, along with a Duty of Loyalty to act in the clients’ best interests) and the RIA’s requirement to avoid or at least disclose any attendant conflicts of interest, along with an updated (re-)interpretation of the solely incidental exemption for broker-dealers providing advice (that such advice will not trigger RIA status at a broker-dealer if the advice is offered “in connection with and [is] reasonably related to the brokerage services provided to an account.”
Ultimately, while Regulation Best Interest did not impose a full fiduciary duty on broker-dealers, it does materially lift the standard of conduct that applies to them, requiring greater disclosures from broker-dealers of their business practices, a requirement for broker-dealers to take active steps to mitigate the conflicts of interest their incentives create for brokers, and an outright ban on certain sales contests, quotas, and similar (and especially problematic) incentives.
For RIAs themselves, the new Regulation Best Interest rules have limited impact (as the new standards are specifically for broker-dealers), and, in practice, Form CRS will likely be easy to comply with (becoming a new Part 3 to Form ADV, drawing primarily from information already provided in the Part 2A brochure, and delivered alongside the RIA’s existing ADV requirements). Which means, in practice, the largest impact to RIAs may not be Regulation Best Interest itself, but simply the difficulty for RIAs to differentiate themselves in a world where broker-dealers can legitimately state that they, too, have a “best interests” standard when providing recommendations to their clients.
In the end, though, it seems that no rule related to the standards of conduct for broker-dealers and RIAs is “final” until it survives the seemingly inevitable court challenges that tend to emerge. Though given that the broker-dealer community itself has largely been supportive of Reg BI – if only because it wasn’t even worse and more burdensome for them – it remains to be seen who might even challenge the SEC’s Regulation Best Interest and supporting rules in the first place.
Without a challenge, the new rules of Regulation Best Interest and Form CRS themselves are set to take effect on June 30th of 2020 (providing a 1-year transition period). Though the ripple effects are likely to continue for years to come.
Topics Covered In This Article
- Background Of SEC’s Regulation Best Interest Proposal
- Final Regulation Best Interest Rule
- Final Form CRS Requirements
- SEC (Re-)Interpretation Of RIA Fiduciary Obligations
- SEC (Re-)Interpretation Of Solely Incidental Exemption For Broker-Dealers
- Compliance Impact For Broker-Dealers
- Compliance Impact For RIAs
- Potential Legal Challenges
SEC’s 2018 Proposal To Lift Broker-Dealer Standards Of Conduct With Regulation Best Interest
Last year, on April 18th of 2018, the SEC issued a series of three new proposals, under what it was calling an effort to “Enhance Protections and Preserve Choice for Retail Investors in Their Relationships With Investment Professionals,” which centered on a new Regulation Best Interest (or “Reg BI” for short) that would lift the existing standard for broker-dealers from FINRA’s current “suitability” standard to requiring that brokers give recommendations in the best interests of their customers… albeit without imposing a full-scale fiduciary duty on broker-dealers to act in the best interests of their customers at all times.
The proposed Regulation Best Interest, and its supporting Form CRS (a Customer/Client Relationship Summary that would further explain to consumers the nature of their relationship with their broker-dealer or investment adviser), generated a whopping 6,000 public comment letters, raising concerns about whether broker-dealer and RIA standards should be fully harmonized (i.e., fiduciary for all types at all times), whether Form CRS would really be effective at communicating the differences between broker-dealer and RIA services, costs, and standards of conduct, and/or whether it would be better to scrap Regulation Best Interest altogether and instead simply actively enforce the existing rules that already require broker-dealers offering more-than-just-incidental advice to register as investment advisers (and become fiduciaries) anyway.
And now, nearly a year after the original proposal, the SEC has taken all the public feedback, made modifications, and issued a Final Rule for Regulation Best Interest and Form CRS, along with two (re-)interpretations of what RIAs must do to comply with their fiduciary duty, and when exactly a broker-dealer’s advice services cross the line to being no longer “solely incidental” to its brokerage services.
SEC Issues Final Rules On Regulation Best Interest (Reg BI) And Form CRS
On June 5th of 2019, the SEC issued its 1,363 pages of final Rules on Regulation Best Interest and Form CRS, including two (re-)interpretations of what RIAs must do to comply with their fiduciary duty, and when exactly a broker-dealer’s advice services cross the line to being no longer “solely incidental” to its brokerage services.
In general, the focus of the SEC’s Regulation Best Interest is to lift the standards of conduct that apply to broker-dealers, with only limited direct impact for RIAs. And, in practice, the SEC’s final version of Reg BI hewed closely to the original proposal, with a number of changes in language and details, but few changes of substance. Similarly, the final version of Form CRS also followed the original proposal closely, but in response to feedback from investors and organizations that did user testing directly with consumers, the SEC did further shorten Form CRS (from a standard 5-page document, as proposed, down to just 2 pages in the end), while making the language on Form CRS less prescriptive and more flexible (for firms to use their own words to explain their own services, albeit while following a standardized flow of key sections that must be covered and key information that must be provided).
Specifically, the SEC’s final rules and interpretations prescribed that:
- Under Regulation Best Interest (Reg BI), broker-dealers will have a General Obligation 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,” and broker-dealers “may not put [their] financial interests ahead of the interests of a retail customer when making recommendations”;
- Both broker-dealers and RIAs will now be required to create and deliver a new Form CRS (Customer/Client Relationship Summary) before or at the time that advice is provided, which explains the types of client/customer relationships and the services the firm offers, the fees, costs, conflicts of interest, and required standard of conduct associated with those relationships and services, and whether the firm and its financial professionals currently have any reportable legal or disciplinary history;
- A (re-)interpretation of an RIA’s obligations as a fiduciary to clients, specifically with regard to when/whether it’s sufficient for RIAs to simply acknowledge they “may” have a conflict of interest (versus more concretely explaining conflicts and their potential impact), and how RIAs should disclose their conflicts of interest pertaining to the allocation of investment opportunities amongst their clients;
- A (re-)interpretation of the “solely incidental” exemption for broker-dealers to avoid the requirement to register as (fiduciary) investment advisers, stipulating that “a broker-dealer’s provision of advice as to the value and characteristics of securities or as to the advisability of transacting in securities is consistent with the solely incidental prong if the advice is provided in connection with and is reasonably related to the broker-dealer’s primary business of effecting securities transactions.”
Ultimately, the SEC emphasized that its goal in creating Regulation Best Interest was deliberately to not harmonize broker-dealers and RIAs, recognizing instead that each fulfill separate functions for consumers and should remain separate choices for consumers… while recognizing in the modern era that consumers often so rely upon the recommendation of a broker-dealer that such recommendations should be made in the “best interests of the retail investor,” similar to the fiduciary best-interests standard that already applies to RIAs in an advice relationship with a client. With the caveat that a broker-dealer’s “best interest” obligation applies only at the time of recommendation itself (not to the ongoing and holistic relationship as it would with an RIA), and broker-dealers will be allowed to retain their existing conflicts of interest (as long as they’re disclosed to customers, and as long as the broker-dealer takes steps to mitigate conflicted incentives for their registered representatives themselves).
Requirements Of The SEC’s Final Regulation Best Interest (Reg BI) [Release No. 34-86031, Rule 15l-1]
In Release No. 34-86031 (File S7-07-18), the SEC provides the core framework of, and a detailed explanation regarding, the final version of Regulation Best Interest.
Henceforth known as Rule 15l-1 (for the new subsection under Section 240 of the Securities Exchange Act where it will be incorporated), the core of Regulation Best Interest is that broker-dealer will now have a “General Obligation” that:
“A broker, dealer, or a natural person who is an associated person of a broker or dealer, when making a recommendation of any securities transaction or investment strategy involving securities (including account recommendations) to a retail customer, shall act in the best interest of the retail customer at the time the recommendation is made, without placing the financial or other interest of the broker, dealer, or natural person who is an associated person of a broker or dealer making the recommendation ahead of the interest of the retail customer.”
What Constitutes A “Recommendation” Under Regulation Best Interest?
To the extent that Reg BI will be triggered when a broker makes a recommendation to a customer, it’s crucial to understand what constitutes a “recommendation” in the first place.
Ultimately, whether a recommendation is made will be based on the facts and circumstances of the situation, but the SEC notes that, generally, the determination will be made based on whether the communication “could reasonably be viewed as a ‘call to action’” to the customer, whether it “reasonably would influence an investor to trade a particular security or group of securities,” and that “the more individually tailored the communication to a specific customer or targeted group, the greater the likelihood that the communication may be viewed as a recommendation.” The key point, though, is that a recommendation must generally have some level of specificity to the particular client and to a particular action that client would take (as contrasted with general education that is non-specific in nature).
In addition, it’s notable that the new Regulation Best Interest applies not only to the recommendation of a securities transaction itself, but also to an “investment strategy,” which the SEC suggests might include recommendations such as to invest in a bond ladder, to engage in day trading, to liquify home equity to invest, or to engage in margin investing.
Furthermore, “recommendations” are deemed to include not just securities and investment strategies themselves, but how they are invested and implemented; consequently, recommendations as to the type of account (e.g., fee-based advisory vs. commission-based brokerage), whether to roll over or transfer assets from an employer retirement plan to an IRA (that will invest in securities), or to take a plan distribution (to open up an investment account with the proceeds) are also recommendations to which Reg BI would apply.
A Broker-Dealer’s Four Obligations Under The Best Interest General Obligation
Ultimately, to comply with its General Best Interest Obligation, broker-dealers will be required to meet four key obligations:
- Disclosure Obligation. Providing certain prescribed disclosure before or at the time of recommendation, about the recommendation and the relationship between the retail customer and the broker-dealer;
- Care Obligation. Exercising reasonable diligence, care, and skill in making the recommendation;
- Conflict of Interest Obligation. Establishing, maintaining, and enforcing policies and procedures reasonably designed to address conflicts of interest;
- Compliance Obligation. Establishing, maintaining, and enforcing policies and procedures reasonably designed to achieve compliance with Regulation Best Interest.
Disclosure Obligations For Broker-Dealers Under Reg BI
The essence of the Disclosure Obligation under Reg BI is to provide “full and fair disclosure, in writing, of all material facts” relating to both the scope and terms of the relationship and the conflicts of interest that are associated with any recommendations provided.
Key aspects of the broker-dealer’s relationship disclosure obligation include:
1) The nature of the relationship, particularly with respect to whether the broker-dealer is acting as such (as a broker or dealer) with respect to the recommendation;
2) The material fees and costs that will apply to the retail customer’s transactions, holdings, and accounts; and,
3) The type and scope of services provided, including any material limitations on the securities or investment strategies involving securities that may be recommended to the retail customer (e.g., a restricted product menu or required use of proprietary products).
Notably, the fact that the broker-dealer must clearly disclose the nature of the relationship with the customer means that, if the broker-dealer is operating solely as a broker-dealer, it will generally be a violation of Reg BI for brokers to use the titles “adviser” or “advisor”, as the SEC states that, “in most cases broker-dealers and their financial professionals cannot comply with the capacity disclosure requirement by disclosing that they are a broker-dealer while calling themselves an ‘adviser’ or ‘advisor’”. However, in the case of dual-registered individuals (as a broker-dealer and an RIA), the fact that they can legally operate as an advisor (wearing the RIA hat) means they are permitted to hold out as such.
On the other hand, the SEC’s requirements for disclosure of fees and costs is less stringent in practice. Given the wide range of potential fees and costs – given the wide range of products that broker-dealers may implement with clients in the first place – the SEC is generally only requiring under Regulation Best Interest that brokers provide disclosure that the nature of the compensation may create conflicts of interest and not the exact levels of all types of commissions and other costs (referring customers instead to the relevant prospectus or similar sales documents where that information can ostensibly be found).
Care Obligations For Broker-Dealers Under Reg BI
The Care Obligation for broker-dealers under Regulation Best Interest is actually substantively similar to the existing care obligation under FINRA Suitability Rule 2111.05, which had a 3-prong test of requiring a Reasonable Basis (that the recommendation would be suitable), Customer-Specific Suitability (based on the customer’s individual investment profile), and ‘Quantitative’ Suitability (that a series of recommendations, as a whole, were still appropriate in the aggregate).
Under the new Regulation Best Interest Care Obligation, broker-dealers will have similar requirements:
The broker, dealer, or natural person who is an associated person of a broker or dealer, in making the recommendation, exercises reasonable diligence, care, and skill to:
(A) Understand the potential risks, rewards, and costs associated with the recommendation, and have a reasonable basis to believe that the recommendation could be in the best interest of at least some retail customers;
(B) Have a reasonable basis to believe that the recommendation is in the best interest of a particular retail customer based on that retail customer’s investment profile and the potential risks, rewards, and costs associated with the recommendation and does not place the financial or other interest of the broker, dealer, or such natural person ahead of the interest of the retail customer;
(C) Have a reasonable basis to believe that a series of recommended transactions, even if in the retail customer’s best interest when viewed in isolation, is not excessive and is in the retail customer’s best interest when taken together in light of the retail customer’s investment profile and does not place the financial or other interest of the broker, dealer, or such natural person making the series of recommendations ahead of the interest of the retail customer.
In fact, a side-by-side comparison of FINRA suitability and the new Care Obligation under Regulation Best Interest reveals that the language is virtually identical, with the caveat that under Reg BI, the standard by which these items are judged is not merely whether they are “suitable,” but also whether they avoid placing the financial interests of the broker-dealer ahead of the customer… and also that in the customer-specific evaluation, “costs” are explicitly cited as a factor that must now be considered.
On the one hand, the fact that the Reg BI Care Obligation aligns to the existing FINRA Suitability framework means broker-dealers will generally be able to use their existing systems and processes (perhaps just lightly adapted) to review the recommendations being made by their brokers. On the other hand, since the ultimate standard by which the actions will be judged is now higher, it remains to be seen how exactly the new standard will be applied when overlaid on the existing FINRA suitability framework.
In fact, the SEC did not actually define “best interests” itself, instead suggesting that, over time, it will provide examples of what “acting in the customer’s best interests” means. Notably, though, the SEC explicitly pointed out that “best interests” is still about understanding a recommendation in the context of a client’s entire situation; it is not about finding the one “best” product, nor an evaluation of every possible alternative, and solely focusing on the lowest cost alone is not a requirement (i.e., a higher-cost product could still be in the client’s best interests if it had other features and benefits commensurate with that cost, that were otherwise right for the customer’s particular situation). Similarly, brokers will not be obligated to refuse a customer’s order (if it’s contrary to the broker’s recommendation), and the Care Obligation will not apply at all to self-directed or unsolicited transactions by a retail customer.
Conflict Of Interest Obligations For Broker-Dealers Under Reg BI
One of the most important issues under a fiduciary duty is the acknowledgment that, not only must fiduciaries act in the best interests of their clients, but that some conflicts of interest are so problematic that fiduciaries must outright avoid them. As a result, one of the most contentious aspects of the Department of Labor’s fiduciary rule, in particular, was whether and to what extent conflicts of interest would have to be mitigated or eliminated, versus merely disclosed instead (with the risk that, once disclosed, it will not be properly managed).
In the case of Regulation Best Interest, the SEC has taken a hybrid approach to handling conflicts of interest, with different treatment for broker-dealers themselves, versus the brokers they oversee. Specifically, the Conflict of Interest Obligation stipulates that:
The broker or dealer establishes, maintains, and enforces written policies and procedures reasonably designed to:
(A) Identify and at a minimum disclose, or eliminate, all conflicts of interest associated with [their] recommendations;
(B) Identify and mitigate any conflicts of interest associated with recommendations that create an incentive for a [registered representative] to place the interest of the broker, dealer, or such natural person ahead of the interest of the retail customer;
(C) Identify and disclose any material limitations placed on the securities or investment strategies involving securities that may be recommended to a retail customer and any conflicts of interest associated with such limitations, and prevent such limitations and associated conflicts of interest from causing the [registered representative] to make recommendations that place [his/her interest] ahead of the interest of the retail customer; and
(D) Identify and eliminate any sales contests, sales quotas, bonuses, and non-cash compensation that are based on the sales of specific securities or specific types of securities within a limited period of time.
In this context, a “conflict of interest” itself is defined as “an interest that might incline a broker, dealer, or a natural person who is an associated person of a broker or dealer—consciously or unconsciously—to make a recommendation that is not disinterested” (which, notably, is the same definition of “conflict of interest” as applied to RIAs from the original SEC v. Capital Gains Research Bureau case that first applied a fiduciary standard and duty to disclose or mitigate conflicts of interest for RIAs to begin with).
Notably, though, the end result of these changes under the Conflict of Interest Obligation under Reg BI is that broker-dealers themselves are not under any obligation to alter their own conflicts of interest (under (A), disclosure alone is sufficient), but broker-dealers are required to mitigate a number of conflicts of interest for their own brokers, including any incentives that may cause brokers to put their own interests (or their broker-dealer’s interests) ahead of their clients, and an outright ban on a wide range of sales contests and sales quotas.
In other words, broker-dealers may still be permitted to proprietary products, revenue-sharing, and shelf-space agreements, or even engage in principal trading around or against their customer, and as long as it’s disclosed to the customer, it’s permitted. However, broker-dealers will be far more limited in their ability to incentivize their brokers towards those behaviors/products in particular (except, perhaps, to the extent that the broker-dealer simply limits its product menu accordingly, which itself is permitted as long as it is disclosed). With the caveat that a too-narrow product shelf could again trigger a violation of the Conflict of Interest Obligation if done in a manner that would “cause” the registered representative to make recommendations not in the customer’s best interests.
Overall Compliance Obligation For Broker-Dealers Under Reg BI
The fourth and final requirement under Reg BI is that broker-dealers must “establish, maintain, and enforce policies and procedures reasonably designed to achieve compliance with Regulation Best Interest as a whole.”
Since the Conflict of Interest Obligation already requires broker-dealers to establish and implement policies and procedures regarding their conflicts of interest, the practical result of this fourth Compliance Obligation is that the broker-dealer must also establish policies and procedures to handle its Disclosure and Care Obligations as well. Per the SEC itself, such policies and procedures might include “controls; remediation of non-compliance; training; and periodic review and testing.”
The Dual Registrant “Safe Harbor” To Avoid Regulation Best Interest
A key aspect of Regulation Best Interest is that it only applies to broker-dealers – specifically to lift up the standards that apply to broker-dealers and their registered representatives – and not RIAs. Which means not only is Reg BI broker-dealer specific… but when it comes to dual-registered advisors (who are both a registered representative of a broker-dealer and an investment adviser representative of an RIA), the Obligations of Reg BI apply only to a broker while wearing the broker “hat” and not when acting in their capacity as an investment advisor.
On the other hand, the SEC did emphasize that a dual-registrant is only an investment adviser with respect to accounts for which he/she actually provides advice and receives compensation – in other words, for advisory accounts. For any brokerage accounts – as well as the overall relationship with the client – the dual-registrant remains first and foremost a broker, and therefore is subject to Regulation Best Interest. Though being subject to Regulation Best Interest only means the broker is subject to a Best Interests standard for a particular recommendation, and not with respect to the overall relationship with the client as an RIA (as well).
On the other hand, the fact that the broker has any relationship to an investment adviser does allow him/her to use the “advisor” or “adviser” titles and hold out as being in the advice business (as advisor/adviser title limitations are solely for brokers who themselves are solely brokers without an RIA affiliation).
Requirements Of The SEC’s Final Rule On Form CRS [Release No. 34-86032]
In Release No. 34-86032 (File S7-08-18), the SEC defines the parameters of the new Customer/Client Relationship Summary (Form “CRS”) that all broker-dealers and RIAs will be required to deliver to their (prospective) clients in the future. Which, notably, means that while Regulation Best Interest itself applies only to broker-dealers and not RIAs, the new requirements of Form CRS apply to both broker-dealers and RIAs (or at least RIAs registered with the SEC).
In essence, Form CRS is intended to be a simple (2-page) disclosure document (down from 5 pages in the originally proposed version, though dual-registrants may provide 4 pages of disclosures, 2 each for their broker-dealer and investment adviser relationship) that highlights for the prospective customer/client three key pieces of information:
1) The services the firm offers and the type(s) of client/customer relationships available
2) Fees, costs, conflicts of interest, and the required standard of conduct, associated with those relationships and services
3) Whether the firm and its financial professionals currently have reportable legal or disciplinary history
In addition to these items, Form CRS would also include hyperlinks or similar references on where prospects can go to obtain more information about the firm and its advisors, along with references to Investor.gov/CRS, a new website resource made available directly from the SEC to provide additional educational resources about brokers and advisers, their differences, and search tools to look up more information about them (e.g., BrokerCheck and the Investment Adviser Public Disclosure [IAPD] websites).
Details Of Required Form CRS Disclosures
To help make Form CRS more easily comparable from one advisory firm to the next, the SEC has prescribed 5 sections, and certain language (or questions to be answered) in each section, that must be addressed: an Introduction, a description of Relationships & Services, a summary of Fees, Costs, Conflicts, and Standard of Conduct, Disciplinary History, and where to go for Additional Information.
Introduction Section Of Form CRS
The introduction section of Form CRS is a standardized template that applies for any/every advisory firm preparing Form CRS, with just slight adjustments to the templated language for RIAs versus broker-dealers.
While the SEC did not precisely prescribe the exact language that firms must use, the Introduction must ultimately contain the following information:
1) State the name of the broker-dealer or RIA, and whether the firm is registered with the SEC as a broker-dealer, investment adviser, or both;
2) Indicate that brokerage and investment advisory services and fees differ and that it is important for the retail investor to understand the differences; and
3) State that free and simple tools are available to research firms and financial professionals at the Commission’s investor education website, Investor.gov/CRS
Fortunately, many of the additional requirements of the Introduction in the original version of Form CRS, including requiring RIAs to explicitly state that they do not provide brokerage services (and vice versa, and that dual-registrants can provide both), and that investors should carefully consider which types of accounts are right for him/her (as the relevant details are covered elsewhere in Form CRS anyway), were not included in the final version of the Form CRS Introduction.
Relationships And Services Section Of Form CRS
The second section of Form CRS is designed to – as the name implies – summarize the nature of the relationship with and services being offered to retail investors. In fact, using the SEC’s new Questions-And-Answers (Q&A) format, the section will have the header “What investment services and advice can you provide me?”
In the original version of Form CRS, the descriptions of relationships and services were based heavily on pre-written text prescribed by the SEC, but in the final version, advisory firms will have more flexibility over the wording they use and how they describe their offering. Nonetheless, firms will be required to provide responses to several core sections:
Description of Services. The firm must explain whether it offers brokerage services or investment advisory services (or both) to investors, along with the types of services, accounts, or investments it makes available (e.g., wrap accounts, execution-only brokerage services, financial planning), and any material limitations on those services. Broker-dealers will be required to explicitly state that they buy and sell securities (in order to clarify their principal services).
Additional details that must be covered in the Description of Services include:
1) Whether the firm provides ongoing monitoring services and at what frequency it monitors (versus providing just upfront advice or one-time/standalone recommendations)
2) The firm’s investment authority (i.e., whether the firm will have discretion of not)
3) Any limited investment offerings (e.g., if the firm offers only proprietary products or a limited menu of products)
4) Account minimums (i.e., whether the firm has any asset or household account minimums)
Additional Information. Firms may also on their Form CRS include hyperlinks out for further information to more deeply describe their offering beyond what fits on Form CRS.
Conversation Starters. The Relationship & Services section of Form CRS, along with subsequent sections, will each have a series of required “conversation starter” questions that prompt consumers what further questions they should ask for additional clarity about the relationship and services offered.
The conversation starters for the Relationship and Services section will include:
– “Given my financial situation, should I choose a [brokerage or investment advisory or both] services?” (Exact wording adapted for broker-dealers, RIAs, or dual registrants)
– “How will you choose investments to recommend to me?”
– “What is your relevant experience, including your licenses, education and other qualifications? What do those qualifications mean?”
Summary of Fees, Costs, Conflicts, and Standard of Conduct Section Of Form CRS
In the original version of Form CRS, the SEC included a series of sections to cover key areas like fees and expenses, conflicts of interest, and standards of conduct, but in the final version of Form CRS, they are all consolidated into subsections of a single section.
Specifically, this third section of Form CRS will have three required areas that all firms must cover: Fees and Costs, Standard of Conduct and Conflicts of Interest, and Financial Professional Compensation and related Conflicts of Interest.
Fees And Costs Disclosures
The fees and costs section will itself have three subsections:
1) Principal Fees & Costs. Under the heading “What fees will I pay?”, firms will be required here to summarize the primary fees and costs that investors will incur for their brokerage and/or investment advisory services (e.g., transaction-based fees for broker-dealers, and asset-based, fixed, wrap, or other direct fee arrangements for RIAs), including how frequently fees are assessed, and any conflicts of interest they create.
2) Other Fees & Costs. Additional fees that investors might incur, directly or indirectly, are included in the “Other Fees & Costs” section, such as custodian fees, account maintenance fees, fees related to mutual funds and variable annuities, and other transactional or product-level fees (e.g., platform fees, shareholder servicing fees and sub-transfer agency [sub-TA] fees).
3) Additional Information. Firms will be required to state, “You will pay fees and costs whether you make or lose money on your investments. Fees and costs will reduce any amount of money you make on your investment over time. Please make sure you understand what fees and costs you are paying.” In addition, firms in the Additional Information section can include hyperlinks or similar cross-references to other, more detailed documentation of their fees and costs (e.g., Form ADV for RIAs, additional Regulation Best Interest disclosures, product prospectuses, etc.).
Notably, and somewhat controversially, broker-dealers and RIAs will not be required to provide detailed information on their exact and actual fees, commissions, and other costs and expenses, in the fees-and-costs area of Form CRS. Instead, given the practical space constraints of a 2-page Form CRS (combined with the somewhat complex and voluminous range of costs that may be incurred in broad brokerage relationships), firms are expected to provide references to the additional and more detailed cost information as a part of the Additional Information subsection (that investors can delve further into themselves on their own).
Conversation Starter. The Fees-and-Costs section will also include the conversation starter question, “Help me understand how these fees and costs might affect my investments. If I give you $10,000 to invest, how much will go to fees and costs, and how much will be invested for me?” Though notably, without yet knowing where/how the investor will be invested at an early juncture (given Form CRS may be provided before any recommendations are being made), the SEC anticipates that advisor may still end out providing responses about the range or types of fees and costs that may be incurred, and not the exact percentages or dollar amount costs.
Conflict of Interest and Standard of Conduct Disclosures
In the original version of Form CRS, the SEC had prescribed very specific wording that broker-dealers or RIAs would be required to use to describe their standard of conduct to consumers… as either “we must act in your best interest and not place our interests ahead of yours when we recommend an investment or an investment strategy involving securities” in the case of brokers, or “we are held to a fiduciary standard that covers our entire investment advisory relationship with you” for RIAs.
However, in consumer testing of Form CRS, investors had trouble understanding the differences between the two standards, and in particular, did not understand the “legal jargon” of the word “fiduciary.”
As a result, in its final version the SEC is allowing more flexibility in how firms describe their standard of conduct, and is requiring both broker-dealers and RIAs to use the wording “best interest” (either with respect to the recommendations being made for a broker, or for the entire advisory relationship for an RIA), and not the word “fiduciary.” (However, notwithstanding some media confusion to the contrary, RIAs will still be permitted to elaborate further in Form CRS on their standard of conduct, and use the word “fiduciary” to subsequently describe that standard in greater detail.)
Once the firm’s standard of conduct is described, it will also be required to describe any other ways that the firm – or its affiliates – make money from brokerage or investment advisory services. This may include disclosing either proprietary products, third-party payments, revenue-sharing, or principal trading activities that the firm engages in. Notably, even if none of these conflicts of interest apply, the firm must come up with at least one material conflict of interest to disclose (e.g., that the RIA receiving asset-based fees has a conflict of interest around making recommendations to pay down a mortgage that would reduce the amount of billable assets being managed).
Conversation Starter. To encourage investors to delve deeper into potential conflicts of interest and standards of conduct, firms will be required to include a conversation starter question “How might your conflicts of interest affect me, and how will you address them?”
In addition, firms will also be required to include cross-reference links to more detailed disclosures, again most commonly either the RIA’s Form ADV or the broker-dealers additional disclosure documents under Regulation Best Interest.
Disclosures For Compensation Payments To Financial Professionals
In a new addition from the original Form CRS proposal, the SEC added a third item to the section, under the header “How do your financial professionals make money?”
In response, broker-dealers and RIAs are expected to summarize how their financial professionals are compensated (including cash and non-cash compensation), and the conflicts of interest those payments create. Relevant examples, per the SEC’s own guidance, include disclosing compensation factors like: the amount of client assets the advisor services; the time and complexity required to meet the client’s needs; the product being sold and/or its associated commission; or the revenue the firm earns from the financial professional’s advisory services or recommendations.
Disciplinary History Section Of Form CRS
In recent years, there has been a growing regulatory focus on better highlighting the disciplinary history of investment advisers and broker-dealers, especially given recent research showing that there is a high recidivism rate for problem brokers (i.e., those who have a prior history of misconduct really are more likely to engage in subsequent misconduct).
Accordingly, Form CRS will have a dedicated new section specifically to provide Disciplinary History disclosures of the RIA or broker-dealer, under the heading “Do you or your financial professionals have legal or disciplinary history?” In turn, Form CRS will either provide a “Yes” or “No” answer, and then provide a link to Investor.gov/CRS for investors to delve further into the firm’s disciplinary history.
Notably, though, the Disciplinary History section only requires that firms disclose whether they have reportable events (at the firm level) or that any of their financial professionals have reportable events. Form CRS will not have a requirement that the individual advisor’s or broker’s disciplinary history be cited on the form; instead, to the extent he/she has a reportable event, the firm will answer “Yes” and the investor is expected to either inquiry further directly, and/or go to the aforementioned online tools to delve further into the disciplinary record of the firm and its advisors or brokers. Alternatively, individuals with a clean disciplinary record will have the option of clarifying that they, personally, do not have any disciplinary events on their record (but must still answer “Yes” to the section on Form CRS to the extent that any financial professionals under the firm have had reportable events).
Conversation Starter. To close out the Disciplinary History section, firms will also be required to include a conversation starter question: “As a financial professional, do you have any disciplinary history? For what type of conduct?”
Additional Information Section Of Form CRS
The end of Form CRS will have an SEC-required section where firms can provide even more/additional information about their firm’s services. Notably, though, the expectation of the SEC is not that firms provide lengthy additional information in the section – given that Form CRS is still constrained to 2 pages – but that instead, it includes additional hyperlinks or other means of facilitating access to additional information.
The Additional Information section must also include a telephone number (regardless of whether the information is already maintained and made available via the firm’s website) where retail investors can request up-to-date information and a copy of the relationship summary.
Conversation Starter. The closing conversation starter of Form CRS will be, “Who is my primary contact person? Is he/she a representative of an investment adviser or a broker-dealer? Who can I talk to if I have a concern about how this person is treating me?”
Delivery Of Form CRS Under New Rule 204-5 And Exchange Act Rule 17a-14
Once effective, Form CRS must be delivered to prospective clients either at the beginning of a relationship with the firm, following a material change to the details of Form CRS, or upon certain events (e.g., when the client re-engages for a new/different relationship or service with the firm).
For broker-dealers, Form CRS will become a new separate disclosure form to provide prospective customers, which is due at the earliest of: 1) when a recommendation is made regarding an account type, a securities transaction, or an investment strategy involving securities; 2) placing an order for the retail investor; or 3) opening a brokerage account for a retail investor. Under Exchange Act Rule 17a-14, a broker-dealer’s Form CRS will also be filed electronically through WebCRD.
In the case of RIAs, the new Form CRS will become Part 3 of Form ADV, and under new Rule 204-5 must be delivered alongside the Part 2A brochure to prospects.
In addition, the new Form CRS will need to be delivered to all existing clients of broker-dealers and RIAs after the rules take effect, and posted to the advisory firm’s current website.
Going forward, advisors will also be required to provide an updated version of Form CRS any time clients: 1) open a new account different from their existing accounts; 2) receive a recommendation to roll over assets from a retirement account; 3) receive a recommendation for a new brokerage or investment advisory service that would not be held in an existing account.
Clarifications Of An RIA’s Fiduciary Duty To Clients [Release No. IA-5248]
In Release No. IA-5248 (File S7-07-18), the SEC provides updated guidance regarding what registered investment advisers are expected and obligated to actually do in order to meet their fiduciary duty to clients.
The interpretation/clarification is significant because an RIA’s fiduciary duty is not actually defined by the SEC itself, nor within the Investment Advisers Act. Instead, it was the famous 1963 Supreme Court case of SEC v. Capital Gains Research Bureau that interpreted the “anti-fraud” requirements of Rule 206(4) of the ’40 Act (that advisors cannot be fraudulent, deceptive, or manipulative in how they hold out to consumers) as effectively meaning that RIAs have a fiduciary duty to their clients.
Accordingly, the SEC guidance formally acknowledges that RIAs have both a Duty of Care and a Duty of Loyalty to clients, which entails:
Duty of Care. An RIA’s fiduciary Duty of Care requires that the firm provides advice in the best interests of the client (which means first gaining a reasonable understanding of the client’s objectives, to begin with), to seek best execution of a client’s transactions (at least where the adviser has the responsibility to select the broker-dealers to execute client trades), and the duty to provide advice and monitoring over the course of the relationship. Notably, though, the exact breadth of an RIA’s duty of care is defined by the scope of the engagement itself; thus, for instance, if the client agrees that the advisor will only provide upfront advice and not ongoing monitoring, the RIA’s duty to monitor does not apply. However, RIAs cannot waive their overarching fiduciary obligation in the aggregate.
Duty of Loyalty. An RIA’s fiduciary Duty of Loyalty requires that the firm not place its own interests ahead of the client’s, including making full and fair disclosure to clients of all material facts relating to the advisory relationship (which is especially important in situations where the advisor has other affiliated businesses or entities as well, such as being dual-registered), and exposing all conflicts of interest “which might incline an investment adviser – consciously or unconsciously – to render advice which was not disinterested” such that the client can make an informed decision whether to consent to the conflict.
While nominally, the SEC’s (re-)interpretation of an RIA’s fiduciary duty appears to largely just codify existing common law fiduciary obligations – that have already long since been applied in the courts – it is notable that, historically, RIAs were expected to both seek to avoid conflicts of interest and, at a minimum, make full disclosure of all material conflicts of interest (per the existing instructions for Form ADV Part 2). In its final interpretive release, though, the SEC merely stipulated that an RIA “must eliminate or at least expose all conflicts of interest…” instead. In other words, RIAs were previously expected to avoid conflicts of interest as best they could, and disclose what they couldn’t avoid; under its new guidance, RIAs can choose to eliminate or merely disclose… perhaps not coincidentally making it akin to the broker-dealer’s own obligation under Regulation Best Interest (which, similarly, is a choice of whether to avoid or merely disclose conflicts).
On the other hand, the SEC did provide additional guidance in previously-grey areas of an RIA’s fiduciary disclosure obligations. For instance, the SEC notes that simply saying an RIA “may” have a conflict of interest is not sufficient (instead, the specific conflict must be disclosed, to ensure that clients can give informed consent), and RIAs trading for multiple clients at once (e.g., block trades that are allocated to client accounts) must have clear policies and procedures to either mitigate or at least disclose whether/how their allocation policies may impact clients (especially in situations where there is not a simple pro-rata allocation of securities).
(Re-)Interpretation Of The “Solely Incidental Advice” Exemption For Broker-Dealers [Release No. IA-5249]
In Release No. IA-5249, the SEC provided an updated interpretation of the “solely incidental” exemption for broker-dealers providing advice without needing to register as investment advisers (and be subject to a full fiduciary duty).
The issue is that, under Section 202(a)(11) of the Investment Advisers Act of 1940, anyone who provides investment advice for compensation and is in the business of providing such services must register as an investment adviser (and be subject to a fiduciary duty thereof). However, Section 202(a)(11)(C) stipulates that:
“…any broker or dealer whose performance of such services is solely incidental to the conduct of his business as a broker or dealer and who receives no special compensation therefor” (emphasis mine)
In other words, people who are in the business of providing (investment) advice for compensation must become RIAs, unless they are serving primarily as brokers and their advice is only incidental to the delivery of their brokerage services. Which, in practice, is why advisors working at broker-dealers aren’t already fiduciaries under current law as it applies to RIAs; because broker-dealers typically maintain that any advice provided by their brokers is solely incidental to their sale of brokerage products.
Historically, the solely incidental exemption was meant to recognize that, in the course of selling stocks and bonds to customers, that brokers may implicitly or explicitly suggest or “recommend” the investment, and it was not the intent of Congress to capture such advice that was “incidental” to the sale as advice. As contrasted with hiring an “advisor” who was clearly in the business of giving advice for compensation, who would have been required to register as an investment adviser.
However, in today’s world, the lines between broker-dealers and RIAs have become far more blurred, as a recent review of 25 leading broker-dealer websites by the Consumer Federation of America found that all of them were using titles and marketing services that implied they were in the business of advice (e.g., “we’ll help you create a plan tailored to your needs” or “[our] financial advisors build long-term relationships with our clients and their families”), even as they were relying on the broker-dealer exemption that any advice being provided would be solely incidental to the sale of brokerage products.
Thus, in response to concerns along these lines raised in public comment letters regarding Regulation Best Interest, the SEC decided to “clarify” its interpretation of what it really means for advice to be “solely incidental.”
Refining The Scope Of The Solely Incidental Prong Of The Broker-Dealer Exemption
In 2005, the SEC released IA-2376 (“Certain Broker-Dealers Deemed Not To Be Investment Advisers”), which provided an exemption to broker-dealers offering fee-based accounts, and in the process interpreted the solely incidental exemption to mean advisory services offered “in connection with and reasonably related to the brokerage services provided.” Ultimately, the rule in IA-2376 was vacated in March of 2007 in the case of Financial Planning Association v. SEC, but the SEC did re-propose this solely incidental interpretation later that year in IA-2652 (“Interpretive Rule Under The Advisers Act Affecting Broker-Dealers”).
And now, under its new Release No. IA-5249 as a part of Regulation Best Interest, the SEC is officially (re-)adopting its previously proposed interpretation, that:
“…a broker-dealer’s provision of advice as to the value and characteristics of securities or as to the advisability of transacting in securities is consistent with the solely incidental prong if the advice is provided in connection with and is reasonably related to the broker-dealer’s primary business of effecting securities transactions.”
Notably, the SEC emphasizes that in this context, the amount (“quantum”) or importance of investment advice that may be provided by a broker-dealer is not determinative as to whether its advice is solely incidental (i.e., the advice does not have to be trivial inconsequential, or infrequent).
However, the SEC does emphasize that certain services will “automatically” cause a broker-dealer to be deemed as being in the investment advisory business. For instance, exercising investment discretion over a client’s accounts generally triggers RIA status for broker-dealers, as they’re no longer merely providing advice in connection with brokerage services, they’re actually making investment decisions on behalf of the client on an ongoing basis (although certain temporary/limited-basis discretion may be permitted, such as giving the broker discretion about the exact timing to execute a specified order, or requesting the broker to execute an order when the customer is otherwise unavailable to approve it). Similarly, providing ongoing monitoring services over an investment account can trigger investment advisory status (beyond the solely incidental exemption), though a broker who merely voluntarily reviews a customer’s account from time to time to identify potential recommendation opportunities will not be deemed to be providing ongoing advice.
In the context of financial planners, it is notable that in its prior 2005 release, the SEC also suggested that when a broker-dealer provides advice as part of a financial plan or in connection with financial planning services, the broker-dealer may not rely on the solely incidental exemption “if it (1) holds itself out to the public as a financial planner or as providing financial planning services, (2) delivers to its customer a financial plan, or (3) represents to the customer that the advice is provided as part of a financial plan or financial planning services.” However, the 2007 re-proposal of the rule did not pick up this financial planning limitation to the solely incidental rule, and the SEC’s final (re-)interpretation of solely incidental as a part of Regulation Best Interest does not (re-)adopt these financial-planning-triggers-investment-adviser-status provisions either.
Effective Date For Regulation Best Interest, Form CRS, And Related Rules
Regulation Best Interest and Form CRS will technically become effective 60 days after they are published in the Federal Register, resulting in it a likely effective date of very late August or early September. However, the SEC is allowing a transition period until June 30th of 2020 for firms to adjust their processes and procedures (and develop their compliance disclosures).
On the other hand, the new interpretations of an RIA’s fiduciary duty and the solely incidental exemption for broker-dealers providing advice will take effect immediately upon publication in the Federal Register.
Notably, the fact that Form CRS will be effective by June 30th of 2020 means that broker-dealers and RIAs will need to create (and file where applicable) their Form CRS beginning May 1st of 2020. New RIAs applying for registration status on/after May 1st will need to include the new Part 3 of Form ADV if their application is filed on May 1st of 2020 or later.
Impact Of Regulation Best Interest And Form CRS For Broker-Dealers And RIAs
Because Regulation Best Interest itself specifically modified the standard of conduct for broker-dealers but not RIAs, while the SEC separately (re-)interpreted the fiduciary duty for RIAs, and Form CRS will ultimately apply to both broker-dealers and RIAs, advisors across the industry will be impacted by the new regulations… but in different ways, depending on the channel they’re currently in.
Compliance Obligations Of Regulation Best Interest And Related Rules For Broker-Dealers
While Regulation Best Interest was not, in the end, a full fiduciary duty for broker-dealers, it does represent a significant increase in the prior suitability standard of conduct that applied to them and will result in significant changes to the industry in the coming year.
Most substantively, Regulation Best Interest requires broker-dealers to change their policies and procedures with respect to the conflicts of interest that exist for their own brokers. As not only does Reg BI outright ban “sales contests, sales quotas, bonuses, and non-cash compensation that are based on the sale of specific securities (or specific types of securities) within a limited period of time,” but it also more generally requires broker-dealers to mitigate any conflicts of interest that create an incentive for their registered representatives to place the interest of the firm (or themselves) ahead of the customer.
While this does not require the elimination of commissions altogether, potential shifts that may come from Regulation Best Interest include:
- A curtailment of especially-high commission products (that may produce an untenable conflict to sell)
- Equalization of compensation within product categories to reduce differential compensation incentives
- Equalization of compensation between proprietary and non-proprietary products (including potential limitations on “integrated grid” payouts that require sales in certain product categories)
- Reforms to product and/or grid compensation payouts that unduly incentivize reaching certain levels of production for higher payouts (e.g., akin to the Department of Labor’s fiduciary rule, the use of graduated grid schedules instead of cliff payout thresholds)
Given the June 2020 effective date for Regulation Best Interest itself, and the decision of the SEC to not explicitly define what constitutes “best interest” for broker-dealers, expect to see ongoing guidance from the SEC both in advance of the effective date, and in the year(s) that follow, providing additional information about what types of broker conflicts are deemed “untenable” and what kinds of conflict-of-interest mitigation broker-dealers are expected to implement for their brokers.
On the other hand, it’s important to recognize that, while Regulation Best Interest does require broker-dealers to mitigate the conflicts of interest around their broker incentives, it does not require the broker-dealer to mitigate its own conflicts of interest. Thus, broker-dealers continue to be permitted to offer proprietary products, receive revenue-sharing and shelf-space agreements, and participate in other conflicted incentive systems… as long as those conflicts are not reflected in the broker’s own compensation incentives.
Still, though, Regulation Best Interest does establish significant new disclosure requirements for broker-dealers, their compensation models, and their conflicts of interest. And while the disclosures for Form CRS itself are fairly limited, the additional disclosures required under the Disclosure Obligation of Regulation Best Interest itself may ultimately shed new light on where and how broker-dealers are being paid, eventually stoking new forms of price and cost competition for consumers.
For the average broker, though, the outcome for Regulation Best Interest will likely be reminiscent of the rollout of the Department of Labor’s fiduciary compliance for broker-dealers as well – firms will make whatever changes they decide to make, and brokers will simply have the choice to take it (and stay with the firm) or leave it (and change to another broker-dealer, or shift to the RIA channel instead). To the extent a broker is dual-registered, though, the scope of Regulation Best Interest means that the advisor’s broker-dealer will likely (continue to) drive compliance obligations for the broker, more so than the RIA (as under Reg BI, the RIA scope for a dual-registered advisor is only to the specific client accounts for which he/she is an investment adviser).
Compliance Obligations Of Regulation Best Interest And Form CRS On RIAs
When it comes to Registered Investment Advisers, the new rules of Regulation Best Interest itself are a moot point, since Reg BI is about changing the standard of conduct that applies to broker-dealers and thus, literally, applies only to broker-dealers, not to RIAs. However, Form CRS does apply to both broker-dealers and RIAs, and consequently, the preparation of a new Form CRS in 2020 will become the primary compliance obligation for RIAs under the new rules.
In practice, developing Form CRS for most RIAs will not likely be burdensome, as it will effectively reference material that is already disclosed in greater detail in the Part 2A brochure of Form ADV. In fact, the whole point of Form CRS is to provide a briefer, easier-to-read-and-scan version of disclosures than the existing Part 2A brochure, with a “layered” approach to disclosure that allows consumers to delve deeper if they wish to (i.e., go from the 2-page Part 3 to the longer Part 2A brochure). For most firms, the new ADV Part 3 will likely take just a few hours with a compliance consultant to prepare, and delivery can be easily managed by simply pairing it with the delivery of the Part 2A brochure that RIAs are already required to prepare.
However, RIAs may still be taken aback by some of the new disclosures that must be placed “front-and-center” on Form CRS. In particular, the requirement to state asset/account minimums upfront, along with a disclosure of how the advisor at the RIA is compensated (and any attendant conflicts of interest the advisor may face because of that compensation), are new. As while it’s not uncommon for RIAs to have minimums, and is arguably a best practice to provide that information upfront (e.g., on the advisor’s website), few RIAs today disclose their minimums upfront (but will be required to going forward). And virtually none talk about the conflicts of interest of their own fee-based advisor compensation (but will again be required going forward).
Still, though, while Form CRS may slightly shift the focus or more directly highlight certain aspects of the RIA’s business practices than was common in the past, substantively most RIAs won’t need to change much to comply (with either preparing and delivering Form CRS, or the broader fiduciary burden that RIAs were already subject to and that the SEC largely just “re-interpreted” to the status quo).
It’s also notable that because the SEC’s rules are, by definition, for SEC-registered investment advisers, the new Form CRS requirements technically won’t apply at all to state-registered investment advisers… at least, until/unless states ultimately choose to adopt their own conforming disclosure rules in the coming years.
Will Regulation Best Interest Face Legal Challenges, Too?
On April 6th of 2016, the Department of Labor passed its fiduciary rule, imposing a requirement for broker-dealers to sign a Best Interests Contract with their customers that they will give advice in the “best interests” of their clients. Which the product manufacturing and distribution industry fought and successfully had vacated a year later, on the basis that brokers are not actually in the business of advice (their marketing to consumers notwithstanding!).
Which serves as an important reminder that, with such a contentious rulemaking process, that even a “final” rule isn’t necessarily final until it has also survived any potential court challenges. And it remains to be seen whether there will be any legal challenges in the case of the SEC’s Regulation Best Interest rule.
Notably, though, the bulk of Regulation Best Interest is literally an increase in the standard of conduct that applies to broker-dealers, and the broker-dealer community itself has been largely positive about the final rule, with former chairman and current SIFMA board member John Taft going to far as to say that Reg BI was “the best we could have hoped for” – given that Regulation Best Interest did not actually impose a fiduciary duty on broker-dealers (as the industry feared), while giving broker-dealers the ability to market that their recommendations are “in the client’s best interests” (undermining the fiduciary differentiation of RIAs).
Some critics have pointed out that the SEC’s authority under Dodd-Frank required that it promulgate new standards for broker-dealers that would be “no less stringent” than the standard applicable to RIAs under the Investment Adviser Act. However, that requirement was under Section 913(g) of Dodd-Frank, and as the SEC itself points out, Congress also gave it direct authority under Section 913(f) of Dodd-Frank “as necessary or appropriate in the public interest and for the protection of retail customers… to address the legal or regulatory standards of care for brokers, dealers, investment advisers, persons associated with brokers or dealers, and persons associated with investment advisers…” In other words, the SEC had authority to harmonize the standards between broker-dealers and RIAs, or to simply lift the standards for brokers. It chose the latter path.
Consequently, if Regulation Best Interest will be challenged in the courts, it’s not entirely clear who will even challenge it, given that the SEC did have authority to issue new rules, and Reg BI is being supported by those who would have been most likely (and had the most direct standing) to challenge it.
At best, it may be up to the RIA community to challenge the final rule – if not Regulation Best Interest itself (which doesn’t apply to RIAs in the first place) or Form CRS (for which there’s little legal ground for challenge as a simple disclosure form), perhaps by challenging the SEC’s (re-)interpretation of the solely incidental exemption (which arguably is anti-competitive by placing a higher burden on advice provided by RIAs than equivalent advice provided by a broker-dealer in connection with its brokerage services).
Otherwise, it appears that Regulation Best Interest is likely here to stay. With ripple effects likely to propagate for years to come.
So what do you think? Does Regulation Best Interest truly lift the standard of conduct for broker-dealers? Will consumers receive the information and disclosures necessary to understand the scope of the relationship and conflicts of interest with broker-dealers versus RIAs, and be able to differentiate between the two? Will Form CRS be effective in helping consumers differentiate between broker-dealers and RIAs? Please share your thoughts in the comments below!