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.