06.14.2019
By John D'Antona

Reactions Mixed to Reg BI Passage

Regulation Best Interest is almost in the books.

And opinions are divided on the final product. It appears to be a case of ‘you can please some of the people some of the time. But you can’t please everyone all of the time.’

Reg BI, as it is more commonly known as is designed to hold broker-dealers to higher and standardized code of conduct. The set of rules also require brokers to raise the standard for giving advice to meet a client’s best interest when recommending stocks, mutual funds and other financial products.

“This action is long overdue,” said Republican-appointed SEC Chairman Jay Clayton of the package, which was first proposed in April 2018. “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 professionals presents significant risk.”

Jay Clayton

Jay Clayton, SEC

The regulation was “the right thing to do,” SIFMA President and CEO Kenneth Bentsen, said on Bloomberg TV right before the June 5 vote. “This is going to be a very tough standard that will ensure a big compliance lift for firms, but the industry is supportive of moving forward on it.”

The rules were passed by Clayton and the agency’s two Republican-appointed commissioners. Robert Jackson, a Democrat appointee, dissented.

In a statement, SIFMA’s Bentsen said that as written, the SEC’s Regulation Best Interest rule will impose a materially heightened standard of conduct for broker-dealers when serving retail clients.

“While principles based, the rule is specific with respect to the duty and obligations brokers owe to their clients, and what steps they must take to comply, including the obligation to eliminate, or disclose and mitigate, certain conflicts of interest,” he said. ”Not even the so-called fiduciary standard under the Investment Advisers Act includes the obligation to eliminate or mitigate conflicts. It is undeniable that this rule will directly enhance investor protection and contribute to increased professionalism among financial service providers.”

He added that 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,” Bentsen concluded.

In particular, SIFMA said that as overseer of the securities markets, Reg BI preserves access and choice for investors while providing significantly enhanced protections in areas that the now defunct DOL Fiduciary Rule sought to address.

Kenneth Bentsen, SIFMA

“The rule includes all of the protections of the former DOL rule, including the duty of loyalty, duty of care and risk mitigation elements.  But it is even more protective than the DOL rule because it applies to all retail brokerage accounts, not just qualified retirement accounts or IRA’s, and is backed by the accountability mechanism of SEC and FINRA examination and enforcement.”

“The new best interest standard addresses perceived shortcomings in consumer protection without placing undue barriers between insurance and financial professionals and their clients,” said Kevin Mayeux, CEO of the National Association of Insurance and Financial Advisors. “The higher standard of care preserves the ability of Main Street investors to receive needed products, services, and advice by not favoring one business model over another. It allows them to choose financial professionals who best fulfill their needs and to compensate those professionals in a way that works best for them, whether through commissions or fees.”

NAIFA has long supported the SEC adopting a regulation requiring financial professionals to work in the best interests of their clients. As a key party in the lawsuit that struck down a Department of Labor rule that would have imposed a fiduciary duty on professionals providing retirement services and advice, the group has argued that the SEC has the necessary expertise and is the proper authority to regulate financial professionals and establish rules governing their relationships with clients.

Sounds great, right?

For Wall Street, SIFMA and SEC’s Clayton, yes. All three were happy with passage but not everyone else was. Knut Rostad, president of the Institute for the Fiduciary Standard, calls it a “catastrophe that will be remembered as black Wednesday.”

Why?

The SEC rules, to be implemented by June 30, 2020, would still allow brokers to recommend products that benefit them, provided they disclose the conflict. Investor advocates, however, say the SEC rules are still too vague in its definition of “best interest” and do not address all investment advice conflicts, including the higher payments that brokers receive for selling products that are more expensive to trade.

Representative Maxine Waters, chairwoman of the U.S. House Financial Services Committee, said the package fell short by failing to require all financial advisors to adhere to “a strong, uniform fiduciary standard of care when providing investors with investment advice,” and called on the SEC to rescind it.

Brendan McGarry, Kaufman Dolowich & Voluck

Brendan McGarry, a partner at Kaufman Dolowich & Voluck who represents securities broker-dealers, directors and officers of financial institutions and registered investment advisers in litigation and regulatory matters noted the following:

As anticipated, the vote was divided along political party lines.

Opponents of the rule appear to be most concerned that the standard being set for broker-dealers is not as high as that historically expected of investment advisers.

Opponents of the rule also appear concerned that guidance on the standard for investment advisers may actually lessen the standard expected of advisers.

Proponents of a higher standard for broker-dealers appear most concerned with conflicts of interest presented by the cost of investments to consumers. It appears that proponents of a higher standard would like to see a more-uniform, lower cost to investors of popular investments such as mutual funds across the board. Such a result may appear to be good for investors as a whole, but opponents of a higher standard argue that not all investments in an asset class are created equal, and the market place should decide compensation rather than the SEC.

It will be very interesting to see what the Department of Labor does next in relation to its likely rulemaking on a fiduciary standard.

Ultimately, whether any practitioner in the financial services has adhered to the applicable standard of care is an exercise in hindsight. Regardless of  how Regulation BI is eventually interpreted, it remains clear that broker-dealers and their representatives will need to clearly document the bases for their recommendations, and how their recommendations were in the customer’s best interest.

McGarry said that Reg BI significantly enhances the standard of care that broker-dealers and their registered representatives owe their clients. In particular, he added that the SEC also adopted a new client relations summary disclosure requirement known as Form CRS, and issued an interpretation of the fiduciary duty requirements that registered investment advisers must follow.

Todd Cipperman, founding principal of Cipperman Compliance Services and author of the new book “The Compliance Advantage: Ten Must-Know Trends to Protect Your Investment Firm” said that the proposed rule won’t satisfy anyone while at the same time making it harder to comply with.

“The SEC should reconcile the standard of care for advisers and broker-dealers that offer investment advice for retail clients. The proposed Reg BI is the worst of all worlds in that it changes the current broker-dealer standard without making it consistent with advisers,” Cipperman said. “With Reg BI, the SEC has essentially satisfied nobody. The brokerage community is displeased with a departure from the suitability standard. And, consumer groups don’t think the standard went far enough. I don’t believe regulation is the same as negotiating where the maxim that “the best solution is one that nobody is completely happy with” applies. The SEC should do the right thing, not the acceptable thing.”

If the SEC narrows the “solely incidental” exception to adviser registration (i.e. brokers can give advice that is solely incidental to their brokerage services), Cipperman added, then brokers may win the battle but lose the war.

“In other words, they may get a standard that is less than fiduciary, but a fiduciary standard will apply in most practical situations affecting advice for retail clients,” he concluded.

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