FINRA Lawyer Blog
A new proposed SEC regulation vows to “enhance the quality and transparency of investors’ relationships with investment advisers and broker-dealers.”
If “Regulation Best Interest” is finally implemented, broker-dealers will be required to “act in the best interest” of their retail customers whenever they recommend any securities transactions or investments.
Following numerous penalties in cases where broker-dealers recommended investments to their retail customers for the sake of personal gain, the proposed regulation is designed to deter financial advisers from this type of behavior, in the SEC’s words, “to make it clear that a broker-dealer may not put its financial interests ahead of the interests of a retail customer in making recommendations.”
Under Regulation Best Interest, registered broker-dealers would have to disclose fees as well as any conflicts of interest that may arise. An Obama-era regulation that was overturned on appeal last March proposed similar terms, and the new SEC regulation is viewed by some as a timely replacement, and extension, for it.
Promulgated by the Department of Labor under the umbrella of the Employee Retirement Income Security Act, and partially implemented during the second half of 2017, the Obama-era rule required brokers offering advice relating to retirement accounts to act without regard to their personal financial interests.
President Trump had already initiated a strategy to obtain a repeal of the rule, when the U.S. Court of Appeals for the 5th Circuits in New Orleans overturned it. This means that, once more, the interests of the SEC and those of our current President appear to be diametrically opposed.
One of the main aspects of the SEC’s proposed regulation relates to the interpretation of what investment advisers’ fiduciary duty to their clients entails.
The goal is to clarify this relationship and an adviser’s legal obligations to retail investors. In practice, this will be, in part, achieved thanks to the implementation of a new disclosure document summarizing all aspects of that relationship: the Client Relationship Summary (CRS). The CRS would inform clients in detail and in simple language about the nature of their relationship with their adviser.
Under the new regulation, certain client communications would require that the broker disclose their registration status with the SEC, and unregistered brokers would not be allowed to use the term “adviser” or “adviser” in their title when communicating with investors.
The SEC’s Chairman, Jay Clayton, who has made repeated efforts to enhance investor protections, said in a press release that he believes the Commission,
“can increase investor protection and the quality of investment services by enhancing investor understanding and strengthening required standards of conduct.” He also emphasized the fact that the SEC does not want this type of rules to restrict “investors’ access to a range of products and services at a reasonable cost.”
As it is customary, the public now has 90 days to comment on the proposed rule, counting from April 18.
The proposal’s highlights, as published by the SEC, are reproduced below.
SEC Proposal’s Highlights
Regulation Best Interest
A broker-dealer making a recommendation to a retail customer would have a duty to act in the best interest of the retail customer at the time the recommendation is made, without putting the financial or other interest of the broker-dealer ahead of the retail customer.
A broker-dealer would discharge this duty by complying with each of three specific obligations:
- Disclosure obligation: disclose to the retail customer the key facts about the relationship, including material conflicts of interest.
- Care obligation: exercise reasonable diligence, care, skill, and prudence, to (i) understand the product; (ii) have a reasonable basis to believe that the product is in the retail customer’s best interest; and (iii) have a reasonable basis to believe that a series of transactions is in the retail customer’s best interest.
- Conflict of interest obligation: establish, maintain and enforce policies and procedures reasonably designed to identify and then at a minimum to disclose and mitigate, or eliminate, material conflicts of interest arising from financial incentives; other material conflicts of interest must be at least disclosed.
Investment Adviser Interpretation
An investment adviser owes a fiduciary duty to its clients — a duty that the Supreme Court found exists within the Advisers Act. The proposed interpretation reaffirms, and in some cases clarifies, certain aspects of the fiduciary duty that an investment adviser owes to its clients.
Form CRS – Relationship Summary
Investment advisers and broker-dealers, and their respective associated persons, would be required to provide retail investors a relationship summary.
This standardized, short-form (4 page maximum) disclosure would highlight key differences in the principal types of services offered, the legal standards of conduct that apply to each, the fees a customer might pay, and certain conflicts of interest that may exist.
Investment advisers and broker-dealers, and the financial professionals who work for them, would be required to be direct and clear about their registration status in communications with investors and prospective investors.
Certain broker-dealers, and their associated persons, would be restricted from using, as part of their name or title, the terms “adviser” and “advisor” — which are so similar to “investment adviser” that their use may mislead retail customers into believing their firm or professional is a registered investment adviser.
Securities lawyer Rob Herskovits, founder of New York based Herskovits PLLC, helps advisers and broker-dealers nationwide accused of violating SEC regulations.
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