After more than a decade of policy debates, yesterday was a red-letter day for the US asset management and broker-dealer industries. The US Securities and Exchange Commission (SEC) voted 3-1 to approve Regulation Best Interest, a set of rules aimed at establishing high level codes of conduct and enhancing transparency between investors and registered investment advisors (RIAs) or broker-dealers. Reaction from various stakeholders to the news suggests that the issue has not been entirely put to rest.
What is the “Regulation Best Interest” rule?
Regulation Best Interest requires US RIAs and broker-dealers to act in the best interests of their retail customers. The rule requires that certain conflicts of interest between an RIA or broker-dealer and their customer be either disclosed or, in some cases, eliminated.
The Commission yesterday voted on four distinct areas within the Regulation Best Interest package:
- Regulation Best Interest standard of conduct for broker-dealers
- Form CRS – a mandatory relationship summary which requires registered investment advisers and broker-dealers to provide easy-to-understand information to their clients.
- Interpretation of fiduciary duties for investment advisors
- Interpretation of “solely incidental”
With a 3-1 vote in favor of Regulation Best Interest, advisors now have four explicit responsibilities:
- Disclosure (CRS Q&A document)
- Duty of Care (including cost considerations)
- Management of Conflicts of Interest (disclose or eliminate)
- Ongoing Compliance (investment rollovers and hold recommendations are also caught by Regulation Best Interest so not just initial buy recommendations)
The final rules hardly diverged from previous proposals and while the new rule goes beyond the mere determination of suitability, it has not entirely satisfied investor advocacy representatives that were seeking a more robust fiduciary standard.
New Form CRS Relationship Summary – What’s changed?
The Form CRS Relationship Summary will require RIAs and broker-dealers to provide retail investors with simple, easy-to-understand information about the nature of their relationship with their financial professional. The final form was tested with investors within the consultation process. However, some in the industry argue that the section which compares the roles of broker-dealers and investment advisors is confusing and even misleading. Further, dually registered entities (e.g. those who are registered as broker-dealers and advisors) are not dealt with distinctly. Under the new regulation, a firm’s legal and regulatory history now becomes easily discoverable for investors. Also, given the recent trend of using digital methods of communication, the Form CRS will also include a hyperlink to a dedicated website page on the SEC’s investor education website, Investor.gov, which offers educational information about broker-dealers and investment advisers. Again, there are both fans and critics of this method of communication.
So not everyone is universally happy with the approved rule?
There has been a wide spectrum of reactions to the final rule set and interpretations.
As the Commissions’ vote clearly indicates, there was not even unanimity within the SEC. Commissioner Robert Jackson Jr., the lone dissenter, expressed his personal disappointment that “investment advisors are not true fiduciaries” since the requirement for an advisor to “put its clients’ interests first” was removed from the final draft.
Industry advocacy groups, including the SEC’s own investor advocate, have also expressed certain reservations. These have primarily focused on the “dilution” of the initial fiduciary duty definition.
In defense of the rule, Chairman Jay Clayton argued that the final decree goes beyond FINRA’s existing suitability standard, citing fiduciary principles that are more stringent than mere disclosure.
The continued focus on “best interest” standards, in the US and globally, represents a fundamental shift in how and what investment products are used to manage retail client assets. It’s clear that the issues of investor protection, managing complexity, and increasing cost transparency aren’t going away.
The dissent of certain stakeholders to the final rule now means it is increasingly likely that even with the SEC Regulation Best Interest rule in place, the debate about fiduciary standards will only amplify. It is highly probable that the fiduciary concept will be further explored at the state level given the negative reactions of some industry constituents. Some states have already started: Nevada and New Jersey recently introduced state fiduciary standards ahead of the SEC rulings. Also, the Department of Labor previously indicated its commitment to identically match the SEC rule set, but not without resistance as some large employment groups have come out against parts. This will likely be revisited, too. The end result of Regulation Best Interest may introduce exactly what was not intended: a patchwork quilt of fiduciary standards operated across state lines spread further across the US funds industry.
Firms now have until June 30, 2020 to comply with the Regulation Best Interest and Form CRS requirements. But Regulation Best Interest, like any regulation that meets a torrent of industry push back, has a lot of unfinished business.