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Good news for investors: Your broker-dealer is going to have to disclose a lot more about what he or she is advising you to buy or sell.
Regulation Best Interest, or Reg BI, is coming into effect June 30 after more than two years of controversy and discussion. It requires broker-dealers — those who buy or sell securities on behalf of clients — to act in the best interest of their clients and to identify conflicts of interests, including financial incentives they may have with the products they are selling.
Critics contend that the measure does not go far enough and that regulators have missed an opportunity to require broker-dealers to adhere to the same fiduciary standards that financial advisors are required to adhere to already.
“Reg BI” came out of a perceived gap in investor protection standards. Under the old rules, broker-dealers were held to what was called a “suitability standard.” This meant they had to recommend investments that were “suitable” for their clients, but not necessarily in their clients’ best interest.
The rule changes became necessary because broker-dealer responsibilities have changed. In the past, they mostly executed trades, but now many provide financial advice as well.
Financial advisors — who provide financial advice on everything from investment management to tax planning to estate planning — are already required to act as fiduciaries, which means they are already required to act in the best interest of their clients.
Here’s a breakdown of what the new rules require:
- Disclosure: Broker-dealers must disclose the capacity in which the broker is acting, the fees, the type and scope of services provided.
- Standards of care: The broker-dealer must be able to articulate the risk, rewards, and costs of what they are doing for the client, and they must make a recommendation in the retail customers’ best interest.
- Conflict of interest: Broker-dealers must develop policies that identify and mitigate conflicts of interest.
Ken Bentsen, CEO of SIFMA, says the new regulation is a major advance for investor protection: “This is a very strong rule, something the firms have taken very seriously, and there is no question this is a higher standard” than the previous suitability standard, he said.
Still, critics have pounced on what they perceive to be shortcomings in the rule. The biggest complaint is that it sets up two sets of rules for those on Wall Street: a fiduciary rule, where financial advisors have a legal and ethical responsibility for managing money in their clients’ best interest, and a fuzzier “best interest” rule for broker-dealers that is not clearly defined.
“This does very little to change the prevailing suitability standard,” Steve Hall, legal director and securities specialist for Better Markets, said. “It’s the suitability rule with a little extra disclosure and a new title. We know that disclosure is not an effective way to protect investors. It is misleading investors into believing they are getting more protections than they really are. This falls far short of what it could and should have done.”
What could they have done? Hall says the Securities and Exchange Commission should have imposed a uniform fiduciary duty, which he says is what Congress said it wanted.
Bentsen notes that investors will get substantial protection under the new regulation: “It has all the hallmarks of a fiduciary standard — including obligations of care, best interest, disclosure, and conflicts management and mitigation.”
So what’s the difference? Thomas Gorman, an attorney with Dorsey Whitney, is one of the country’s pre-eminent experts on SEC enforcement and insider trading. He noted the difference was largely around how long the broker-dealer was required to act in the best interests of the client.
“A fiduciary has the obligation to act in your interest continuously,” he said. “Reg BI does not — it says in these limited circumstances, when you are making the recommendation, you have to act in their best interest, but once it’s done, it’s done. It only applies in a narrow circumstance when you are making the recommendation.”
Given all the confusion, why did the industry oppose a fiduciary standard? Gorman feels much of the concern was over potential lawsuits, including something as frivolous as whether a broker-dealer has an obligation to recommend the lowest-cost funds. Reg BI doesn’t specifically require brokers to routinely recommend the lowest cost funds. Cost is one factor among several that can be considered.
Gorman said he disagreed with those concerns: “The idea you will have lawsuits does not make any sense to me. If broker-dealers take on a fiduciary obligation, there is no reason to think they would face any more lawsuits than financial advisors who already have a fiduciary obligation.”
What’s next? The law is under challenge in the U.S. Court of Appeals for the Second Circuit, and the court has agreed to an expedited hearing.
After that, inspection and enforcement of Reg BI will be largely up to the SEC and FINRA, the regulatory agency that oversees broker-dealers.
And that, Gorman says, is where this regulation will be defined: “You will get it defined around the case law that develops around this. You will hear the lawyers say Reg BI is not the same as a fiduciary duty and they’re going to try to water it down.”
Still, Gorman says getting Reg BI on the books is a big deal for the SEC and particularly for Chairman Jay Clayton, who made it one of the centerpieces of his administration. “Reg BI is a significant accomplishment for Clayton because he has partially filled the gap between the standards that govern brokers and the standards that govern investment advisors.”
The bottom line, according to Gorman: “This is better than the old rule, but it’s very confusing.”
