“The new package of rules is designed to enhance the quality of retail investors’ relationships with broker- dealers and investment advisers.”

On June 5th, 2019, the Securities and Exchange Commission (SEC) voted to adopt a package of rules designed to enhance the quality and transparency of retail investors’ relationships with both investment advisers and broker-dealers.1 In a press release the SEC stated that these actions, which include Regulation Best Interest, and the new Form CRS Relationship Summary, are designed to strengthen and clarify the standards of conduct that apply to broker-dealers and investment advisers, to allow retail investors to better understand and compare the services being offered to them, and encourage greater consistency in the level of protections provided by both financial professionals.2 The rules were passed by SEC Chair Jay Clayton, and the Agency’s two other Republican appointed commissioners, with a Democrat appointee dissenting.3 “This action is long overdue” said Clayton, “The differences between broker-dealers and investment advisers, and how they interact with their customers and clients, make it clear that a ‘one size fits all’ approach to regulating standards of conduct for financial professional presents significant risk.”4 The passing of these new rules caps a ten year battle over regulation of the investment advice industry, and last year lobby groups were successful in having the Obama era Fiduciary Rule proposed by the Department of Labor (DOL) overturned.5 The new rules are considered to be a win for Wall Street, as unlike the Department of Labor Fiduciary Standard, they allow brokers to recommend products that benefit them, provided they disclose the conflict to the client.6

What this means

Investors will be entitled to recommendations and advice that is in their best interest, and does not favor the interests of the broker-dealer or investment adviser. Regulation Best Interest and Form CRS will become effective 60 days after publication in the Federal Register, and there will be a transition period until June 30th, 2020, to give financial firms sufficient time to comply.7

Regulation Best Interest – the new rule imposes a new standard of conduct specifically for broker-dealers that substantially enhances standard of conduct beyond existing suitability obligations, and details specific requirements to address certain aspects of the relationship between broker-dealers and their retail clients, including certain conflicts related to compensation.8 The main components include:9

  • Disclosure Obligation – broker-dealers are now required to disclose material facts about their recommendations, including disclosures about the capacity in which they are acting, and the type of services and fees provided.
  • Care Obligation – reasonable diligence and care to be exercised when a broker-dealer makes a recommendation to a retail customer, and the risks, rewards and costs pertaining to a recommendation are to be in the retail customers’ best interest.
  • Conflict of Interest Obligation – written policies and procedures to be established which are designed to identify, disclose or eliminate any conflicts of interest. These policies are to mitigate conflicts which would put the interests of the firm ahead of the retail customers’ interest, and eliminate any sales quotas and bonuses based on the sale of specific securities.
  • Compliance Obligation – broker-dealers to establish, maintain and enforce policies and procedures designed to comply with Regulation Best Interest as a whole.

Form CRS Relationship Summary – Investment advisers and broker-dealers will now be required to deliver a relationship summary to retail clients at the beginning of any relationship and disclose the firm’s legal standard of conduct, fees, services and other important information relating to the client relationship.10

In addition, the new rule adds an “Investment Adviser Interpretation” and a “Solely Incidental Interpretation” to help distinguish between investment advisers and broker-dealers. Investment advisers owe a fiduciary duty to their clients under the Advisers Act, and this applies to the entire relationship between them. Broker-dealers are excluded from the application of the Advisers Act, when the performance of their advisory services is solely incidental to the conduct of the firm’s business as a broker-dealer, and the advice provided is related to the broker-dealers primary business of executing securities transactions.11 

Conclusion

Typically, the financial planning world has been broken into two categories, broker-dealers that sell products across asset classes, and investment advisers who engage in investment and financial planning advice, and while investment advisers are held to a fiduciary standard, broker-dealers have until now been held to a suitability standard.12

The new rules are expected to enhance the standard of conduct that broker-dealers owe to their retail clients, and provide additional transparency and clarity to retail investors, and generally expand the higher standard of care to everyone providing investment advice.13 Jay Clayton has indicated that the rules would raise the standard for what is considered to be in an investor’s best interest for both broker-dealers and investment advisers, together with addressing industry requests for detailed guidelines to ease compliance.14 However, investor advocates have said the rule is still too vague in its definition of “best interest”, missing clear guidance on what is best interest or incidental advice, and Representative Maxine Waters, chairwoman of the U.S. House Financial Services Committee, indicated the package fell short by failing to require all financial advisers to adhere to “a strong, uniform fiduciary standard of care when providing investors with investment advice.”15 In a statement, the Securities Industry and Financial Markets Association (SIFMA) supported the key elements of the rule, stating that it includes all the protections of the DOL rule, but is even more protective for investors because it applies to all retail brokerage accounts, not just qualified retirement accounts and individual retirement accounts, and is backed by the accountability mechanism of the SEC and Financial Industry Regulatory Authority (FINRA) examination and enforcement.16 SIFMA President and CEO Kenneth E. Bentsen, Jr. stated “Compliance with the rule will not be easy for the industry. Firms will need to make substantial changes. The costs to implement will no doubt be significant, but, we believe, worthwhile to uniformly enhance investor protection to the level investors should and do expect, while preserving investor choice and access to investment advice.”17

References

  1. “SEC Adopts Rules and Interpretations to Enhance Protections and Preserve Choice for Retail Investors in Their Relationships with Financial Professionals,” U.S. Securities and Exchange Commission, Press release, June 5, 2019. Access at: https://www.sec.gov/news/press-release/2019-89.
  2. Ibid
  3. “U.S. SEC adopts rules to prevent broker conflicts, boost disclosure,” Reuters, June 5, 2019. Access at: https://www.reuters.com/article/us-usa-sec-bestinterest/u-s-sec-adopts-rules-to-prevent-broker-conflicts-boost-disclosure-idUSKCN1T617O.
  4. Ibid
  5. Ibid
  6. Ibid
  7. “SEC Adopts Rules and Interpretations to Enhance Protections and Preserve Choice for Retail Investors in Their Relationships with Financial Professionals,” U.S. Securities and Exchange Commission, Press release, June 5, 2019. Access at: https://www.sec.gov/news/press-release/2019-89.
  8. Ibid
  9. Ibid
  10. “SEC Adopts Rules and Interpretations to Enhance Protections and Preserve Choice for Retail Investors in Their Relationships with Financial Professionals,” U.S. Securities and Exchange Commission, Press release, June 5, 2019. Access at: https://www.sec.gov/news/press-release/2019-89. “SEC Brings Increased Confusion For Investors With New ‘Best Interest’ Rule,” Forbes, June 5, 2019. Access at: https://www.forbes.com/sites/jamiehopkins/2019/06/05/sec-brings-increased-confusion-for-investors-with-new-best-interest-rule/#22d2ae72270b.
  11. “SEC Adopts Rules and Interpretations to Enhance Protections and Preserve Choice for Retail Investors in Their Relationships with Financial Professionals,” U.S. Securities and Exchange Commission, Press release, June 5, 2019. Access at: https://www.sec.gov/news/press-release/2019-89.
  12. “SEC Brings Increased Confusion For Investors With New ‘Best Interest’ Rule,” Forbes, June 5, 2019. Access at: https://www.forbes.com/sites/jamiehopkins/2019/06/05/sec-brings-increased-confusion-for-investors-with-new-best-interest-rule/#22d2ae72270b.
  13. Ibid
  14. “U.S. SEC adopts rules to prevent broker conflicts, boost disclosure,” Reuters, June 5, 2019. Access at: https://www.reuters.com/article/us-usa-sec-bestinterest/u-s-sec-adopts-rules-to-prevent-broker-conflicts-boost-disclosure-idUSKCN1T617O.
  15. Ibid
  16. “SIFMA Statement on the SEC’s Final Regulation Best Interest Rule,” SIFMA, June 5, 2019. Access at: https://www.sifma.org/resources/news/sifma-statement-on-the-secs-final-regulation-best-interest-rule/.
  17. Ibid

Newsletter Author: Venetia Woo, Mairi Bryan

Newsletter Contact Person: Venetia Woo

Visit www.accenture.com/RegulatoryCompliance for latest insights on regulatory remediation and compliance transformation.

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