On June 5th, the SEC voted to adopt new rules and interpretations that were designed to enhance the quality and transparency of retail investors’ relationships with investment advisers and broker-dealers. This brings the legal requirements and mandated disclosures in agreement with reasonable investor expectations while preserving access to various investment services and products in terms of choice and cost. These actions are meant to clarify the standards of conduct applicable to broker-dealers and investment advisers, help retail investors better understand and compare offered services and make an informed choice of the relationship best suited to their needs and circumstances, and support better consistency in the level of protections provided by each regime, particularly when a recommendation is made. Specifically, the rules enhance consumer protections while ensuring choices in: 1) the type of professional with whom consumers work, 2) the services they receive, and 3) how they pay for these services.
Thursday, June 13. 2019
These rules and interpretations apply to Regulation Best Interest, the new Form CRS Relationship Summary, and two interpretations under the Investment Advisers Act of 1940. Under Regulation Best Interest, broker-dealers will be required to act in the best interest of a retail customer when making recommendations to that customer about any securities transaction or investment strategy involving securities. Regulation Best Interest will also enhance the broker-dealer standard of conduct beyond existing obligations and clarify that a broker-dealer may not put its financial interests ahead of the interests of the retail customer. Regulation Best Interest will feature the following components:
- Disclosure Obligation – Broker-dealers must disclose material facts about its relationship and recommendations, including specific information about the capacity in which the broker is acting, fees, the type and scope of services provided, conflicts, limitations, and whether the broker-dealer provides monitoring services
- Care Obligation – Broker-dealers must employ reasonable diligence, care, and skill when making a recommendation to a retail customer. Potential risks, rewards, and costs associated with the recommendation must be understood. These factors must then be taken into account when the broker-dealer makes a recommendation to ensure that recommendation is in the best interest of the customer. The final regulation, which is an enhancement from the original proposal, requires the broker-dealer to consider the costs of the recommendation.
- Conflict of Interest Obligation – Broker-dealers must establish, maintain, and enforce written policies and procedures that identify and disclose or eliminate conflicts of interest. This is also an enhancement from the proposal and includes: mitigating conflicts that create an incentive for the firm’s financial professionals to place their or the firm’s interests above those of the retail customer, preventing material limitations on offerings from causing the firm or its financial professionals to place their interests above those of the retail customer, and eliminating sales contests, sales quotas, bonuses, and non-cash compensation that are based on the sale of specific securities or types of securities.
- Compliance Obligation – In another enhancement from the proposal, broker-dealers must establish, maintain, and enforce
policies and procedures to achieve compliance with Regulation Best Interest as a whole.
Additionally, the Form CRS Relationship Summary requires registered investment advisers and broker-dealers to provide investors with information about the nature of the customer’s relationship with
their financial professional in clear, easy-to-understand language. The format of the relationship summary will permit comparability among the different types of firms in a way that is distinct but still facilitating layered disclosure. In addition, Form CRS will include a link to a dedicated page on the SEC’s investor education website, Investor.gov, which offers further educational information about broker-dealers, investment advisers, and other materials.
With these new rules, the SEC also issued interpretations to reaffirm and clarify its view on the fiduciary duty that investment advisers owe their clients under the Advisers Act. One interpretation (the Investment Adviser Interpretation) is intended to more clearly delineate when a broker-dealer’s performance of advisory activities causes it to become an investment adviser within the Advisers Act. Also, the Solely Incidental Interpretation excludes from the Advisers Act those brokers or dealers whose performance of advisory services is solely incidental to the conduct of their business without the receipt of compensation for those services.
Regulation Best Interest and Form CRS will become effective 60 days after publication in the Federal Register. There will be a transition period until June 30, 2020 to allow firms sufficient time to come into compliance. The interpretations will become effective immediately upon publication in the Federal Register. The SEC does recognize the fact that these new rules may require various market participants to make perhaps substantial changes to their operations, including changes to mandatory disclosures, marketing materials, and compliance systems. The SEC is establishing an inter-Divisional Standards of Conduct Implementation Committee to aid firms with planning for these new rules. Questions can be emailed to IABDQuestions@sec.gov.
SEC Adopts Rules and Interpretations to Enhance Protections and Preserve Choice for Retail Investors in Their Relationships With Financial Professionals (www.sec.gov)
Regulation Best Interest: The Broker-Dealer Standard of Conduct (www.sec.gov)
Form CRS Relationship Summary; Amendments to Form ADV (www.sec.gov)
Commission Interpretation Regarding Standard of Conduct for Investment Advisers (www.sec.gov)
Commission Interpretation Regarding the Solely Incidental Prong of the Broker-Dealer Exclusion from the Definition of Investment Adviser (www.sec.gov)