The Securities and Exchange Commission has approved a new rule for broker dealers that market participants expect will require a lot of compliance work for dealer firms and may even require changes to muni market rules.
On Wednesday, the SEC approved its new Regulation Best Interest by a3-1 margin, with Commissioner Robert Jackson voting against the rule. The new rule will strengthen the broker-dealer standard of conduct beyond existing suitability obligations and make it clear that a broker-dealer may not put its financial interests ahead of the interests of retail investor. It will also require both broker-dealers and investment advisers to state clearly key facts about their relationships with their customers, including financial incentives.
The Municipal Securities Rulemaking Board already has rules imposing on municipal securities dealers responsibilities to determine that a recommendation or transaction is suitable for a customer and to attempt to execute transactions at prices as favorable to the customer as possible under prevailing market conditions.
The new rule addresses some of the same subject matter as certain MSRB rules, such as suitability, said Lynnette Kelly, MSRB president and CEO.
“We will need to evaluate the full extent of its application to the municipal market and potentially amend our rules in light of the new federal standard,” Kelly said. “We will coordinate with FINRA (the Financial Industry Regulatory Authority) to minimize burdens on dealers who conduct municipal and non-municipal transactions.”
The new rule will also apply to account recommendations such as rolling over or transferring assets in a workplace retirement plan account to an IRA.
"These recommendations are often provided at critical moments (such as at retirement) and may be irrevocable, can involve a substantial portion of a retail investors net worth, and can have significant long-term impacts on the retail investor," Clayton said.
Broker-dealers also have to disclose material facts about their relationships with their customers, including material fees and costs the customer will incur and the type and scope of services provided.
The original proposal for the rule came after a battle over a Department of Labor rule that sought to place a fiduciary duty on all financial professionals involved in the management or advising of retirement accounts. A federal appeals court struck down that rule, putting the ball in the SEC’s court.
Reg Best Interest, though not as strong as it could have been, is a step in the right direction and an improvement in the existing suitability standard for broker-dealers, Rick Fleming, the SEC’s investor advocate wrote in a statement.
“However, what investors have gained in Reg BI has been undermined by what investors have lost in the Commission’s interpretation of the fiduciary duty that applies to investment advisers,” Fleming wrote.
Reg Best Interest is an improvement to the existing standard of conduct for broker-dealers, Fleming wrote, because it will eliminate sales contests, require better disclosure about conflicts of interest, require brokers to consider costs to the investor of a recommended product and a more careful review of limited product menus.
However, Reg Best Interest will allow broker-dealers and their associated persons to market themselves as acting in the best interest of their customers, Fleming wrote.
“If Reg BI is not enforced rigorously enough to demand behavior that matches customers’ expectations, then customers will be harmed by the new standard,” Fleming wrote.
The Securities Industry and Financial Markets Association said the rule will impose a heightened standard of conduct for broker-dealers serving retail clients.
SIFMA President and CEO Kenneth Bentsen noted that the new rule includes the obligation to eliminate, or disclose and mitigate certain conflicts of interest, adding that the Investment Advisers Act does not require elimination or mitigation. Bentsen wrote that the new rule will enhance investor protection and lead to increased professionalism among financial service providers.
“Compliance with the rule will not be easy for the industry,” Bentsen wrote. “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.”
SIFMA supports elements of the rule that say recommendations must be in the retail customer’s best interest and that broker-dealers must eliminate, or disclose and mitigate material conflicts of interest.
SIFMA also showed support for the requirement that broker-dealers exercise “diligence, care and skill” in making recommendations, which they say will enhance supervisory and compliance regimes to benefit retail investors.
The rule definitely heightens the suitability standard, said Ronald Bernardi, principal and chief executive officer at Bernardi Securities, because for the first time it explicitly says broker-dealers have to put clients’ interests of their own.
“It definitely raises the bar for market participants and progress,” Bernardi said. He called it a huge step in the right direction.
Disclosures will be amplified and it is up to professionals to satisfy the intent of the rule, Bernardi said. He also said it provides clarifications to investors.
Jackson said the rule failed to require that investor interests come first, noting that Congress authorized the SEC to do so in the Dodd-Frank Act.
“Instead, the core standard of conduct set forth in Regulation Best Interest remains far too ambiguous about a question on which there should be no confusion,” Jackson said. “As a result, conflicts will continue to taint the advice American investors receive from brokers.”
Reg Best Interest was released as part of a package of proposals that also include an explicit codification of a long-standing interpretation that investment advisers owe their clients a fiduciary duty and a new disclosure form for both dealers and investment advisers to make clear to their retail customers the scope and nature of their relationship.
The Form CRS Relationship Summary would require registered investment advisers and broker-dealers to provide retail investors with “easy-to-understand” information about the nature of their relationship with their financial professional.
SEC members said the form could then allow investors to compare information among firms and allows for broker dealers to use their own working in describing themselves to investors.
“The final rule also substantially weakens even the proposal's limited requirement that firms mitigate the conflicts their brokers face, allowing the conflicts to be resolved through disclosure alone,” Jackson said of the form.
