Eight years after receiving a directive from Congress to consider standards of conduct for investment recommendations, the Securities and Exchange Commission (SEC) has issued proposed guidance for broker-dealers and registered investment advisors who make recommendations to retail clients. Unlike the DOL fiduciary regulations, the guidance applies only to securities; not to traditional bank, credit union, and insurance investment products. Many had hoped for a uniform standard for brokers and registered investment advisors (RIAs), however this guidance does not take that approach.
Who will regulate investment advising behavior?
This SEC guidance comes at a time of uncertainty for oversight of investment advising relationships. After the U.S. Department of Labor (DOL) issued final regulations on fiduciary investment advice for retirement savers, a court case recently resulted in a finding that the DOL exceeded its authority. Unless the DOL or another party successfully appeals, the DOL’s guidance will be nullified. This would leave the SEC regulations—if finalized—as the standard for broker-dealers who make investment recommendations.
What is in the guidance package?
The SEC has issued two proposed regulations and a proposed interpretation.
- Regulation Best Interest for broker-dealers
- Clarification on fiduciary obligations for registered investment advisors
- New disclosure requirements in the form of a Customer Relationship Summary; plus restrictions on broker-dealers not calling themselves advisers or advisors.
SEC Best Interest Standard ≠ DOL Best Interest Contract
The SEC’s proposed “regulation best interest” is not the same as the legally-enforceable “best interest contract” (BIC) in the DOL fiduciary investment advice regulations. Instead, the SEC’s best interest standard would be enforceable under its current arbitration framework. To satisfy the proposed SEC guidance, a broker-dealer must “act in the best interest of the retail customer” when a recommendation is made, and not put his own financial or other interest ahead of the customer. Broker-dealers can accomplish this by meeting the following conditions.
- Disclose the nature of the broker-dealer/client relationship (which for brokers is not a fiduciary relationship, as it is for RIAs), and any material conflicts-of-interest—including financial incentives that might cause a broker-dealer to put his interests ahead of the customer’s.
Exercising reasonable diligence, care, skill and prudence to:
-Understand the investment product recommended to a customer
-Determine that this recommendation could be in the interest of some customer
-Determine that a recommendation is in a particular customer’s best interest based on her investment profile
-Determine that a proposed series of transactions is also in that customer’s best interest based on her investment profile
Conflict of Interest: Disclosure, Mitigation, and Elimination
Establish, maintain, and enforce written policies and procedures to identify material conflicts-of-interest due to financial incentives tied to investments and either disclose and mitigate such conflicts, or eliminate them.
Contents of the Customer Relationship Summary
While the SEC guidance is primarily directed to broker-dealers and the securities recommendations they make, a new disclosure requirement applies to both broker-dealers and RIAs. These regulations would require both to make clear their roles in a brief “customer relationship summary” (CRS) form that includes
- an introduction highlighting the types of investment services and accounts offered to retail investors
- a description of the relationships and services a firm offers to retail investors, including the legal standards of conduct to be expected (e.g., RIAs are fiduciaries, broker dealers are not)
- a description of the fees and costs a retail investor would pay the firm
- a comparison of brokerage and RIA services (for firms that are one or the other, but not both)
- a description of the conflicts-of-interest that may exist, including compensation that differs based on investments chosen.
- how a customer can get additional information, including legal and disciplinary actions involving the firm or representative.
- key questions a retail investor may want to ask for greater detail about services, specific fees, etc.
In general, the SEC advises representatives to be direct and clear about their status as a broker-dealer or RIA—or dual status—and to refrain from using language or terms formally or informally that may mislead a customer. Form CRS must be filed electronically with the SEC.
Fiduciary standard clarifications
While the fiduciary standard is not new for registered investment advisors, the SEC has never before formally included “best interest” obligations as part of their interpretation of the fiduciary obligations for RIAs. They define the prongs of the fiduciary standard of conduct to include:
- Duty of Care
- Duty to provide advice that is in the client’s best interest
- Duty to seek best execution
- Duty to provide services and to provide advice and monitoring over the course of the relationship
- Duty of Loyalty
- Duty to put its client’s interests first and not favor one client over another
- Duty to make full and fair disclosure of all material facts relating to its relationship with its client
- Duty to seek to avoid conflicts of interest and, at a minimum, disclose all material conflicts
Who is covered by the SEC guidance?
Unlike the DOL’s fiduciary investment advice regulations, the SEC broadens the pool of investors captured by its new investor protection rules. The SEC’s proposed regulations are not specific to retirement savers but instead cover the general retail investor.
The SEC guidance, however, also narrows the pool of investment recommendation providers covered by the guidance as its new rules only apply to broker-dealers and registered investment advisors. The guidance does not generally apply to personnel of banking or insurance organizations.
Which activities fall under the SEC guidance?
The three components address activities with respect to securities investments, such as stocks, bonds, and mutual funds, for retail clients. This includes the purchase, sale, or holding of such investments. By comparison, the DOL fiduciary rules apply to a broader class of investments than just securities. The DOL rule includes investments in certificates of deposit and certain insurance products that are not governed by the SEC framework.
While the SEC guidance is somewhat ambiguous, it appears to cover retirement plan participants receiving direct investment recommendations but exclude employer plans as a business exception. The guidance also appears to cover investors in individual tax-advantaged accounts such as IRAs, health savings accounts, and education savings accounts.
Clarifications on these and certain other issues are being sought.
More to come
The SEC requests comments from the public on this guidance, during a 90-day period. Based on public comments made by SEC commissioners, these SEC proposed regulations and disclosure guidelines could be just the first elements of more comprehensive guidance from the agency on investment advising relationships. If true, more guidance may be forthcoming. Visit ascensus.com and subscribe to our Industry and Regulatory news feed for the latest developments.
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