On June 5, 2019, a new set of regulations from the Securities and Exchange Commission (SEC) was introduced. The package aims to “enhance the quality and transparency of retail investors’ relationships with investment advisers and broker-dealers, bringing the legal requirements and mandated disclosures in line with reasonable investor expectations, while preserving access (in terms of choice and cost) to a variety of investment services and products.”
Consisting of Regulation BI, the new Form CRS Relationship Summary, and two interpretations of a previous law, these regulations clarify the roles and responsibilities of financial advisors so that investors have a better understanding of services and products in order to make more informed decisions about how they use their money.
All of this might seem pretty straightforward, but there are some details worth unpacking.
Broker-Dealers and Other Advisors
Regulation Best Interest (Regulation BI) can be thought of as the next iteration of the Department of Labor’s fiduciary rule for financial advisors. Regulation Best Interest lays out new transparency terms and standards of conduct compelling broker-dealers to act in the investor’s “best interest.”
To understand why this matters, it is important to explore the problem more fully. Between investment advisors, financial advisors, brokers, and registered investment advisers, there are plenty of names to go around for different types of money managers. And while there might be a lot of overlap, the differences can make a big impact on the advice you are given about your potential investments.
For example, registered investment advisors are beholden to the Investment Advisers Act of 1940, which binds them to a fiduciary standard and obligates them to disclose all fees and conflicts of interest.
Brokers, on the other hand, only have to register with the private Financial Industry Regulatory Authority. While brokers are held to a “suitability rule” ensuring that they have reasonable grounds for advising on a trade, they also make a commission on those trades. This can lead to a situation in which your broker can make a “reasonable” product recommendation, but their priority is the size of their own commission — not the investor’s best interest.
Regulation Best Interest makes it easier for retail investors to understand what type of professional they are working with so they can make more clear-eyed assessments of the advice they are getting.
A Recent History of Fiduciary Standards
In the middle of the 2010s, the Obama administration sought to introduce new regulations through the Department of Labor that obligated financial advisors to adhere to a fiduciary standard. That was limited to financial advice relating to retirement plans like IRAs and 401(k)s. The case in favor of the new rules was that, because pension plans were on the decline, individuals today are bearing a much greater responsibility for investing in their retirement when compared to previous generations.
The rule was on its way into effect, but it was blocked by a federal appeals court in 2018, a ruling that was not contested. Regulation Best Interest is the next federal attempt to inject the financial services industry with new measures for protecting retail investors.
What Is Regulation Best Interest?
Regulation Best Interest makes things better by requiring brokers not to refer to themselves as advisors if they are not held to a fiduciary standard. Other obligations for brokers include:
- Disclose information related to their advice. Brokers have to tell their clients what factors led to their decision to recommend a specific product, service, or strategy, and that information must be presented by the time of the recommendation.
- Exercise due diligence and care. Brokers should have a reasonable basis for believing their recommendations are actually in their clients’ best interest.
- Adhere to conflict of interest policies. Brokers must create policies preventing them from acting on conflicts of interest, and they must disclose all potential conflicts of interest to their clients.
- Fully comply with the procedures of the regulation. On top of what is specifically outlined in Regulation BI, brokers should create their own policies to ensure the client’s best interest.
The Regulation is complemented by Form CRS, which documents the summary of the relationship between the broker and the client. This includes all fees, conflicts of interest, and standards of conduct — as well as information about the firm’s legal or disciplinary history.
Regulation BI Gets Mixed Reviews
Brokers see a lot to like in Regulation Best Interest — in particular its recognition of the different incentive models at play in the profession. Form CRS also gives them an opportunity to strike a balance between giving clients the disclosures they need without overloading them with irrelevant information.
Other voices in support praise the regulation’s goal of increased clarity and transparency — but they have their concerns as well. While Form CRS can be helpful, it is also less likely to be seriously reviewed by clients. Anyone who has signed an online Terms of Service (TOS) Agreement knows that there is little patience to go around when it comes to reading through dense and technical documentation.
Some feel that, although Regulation Best Interest is a step in the right direction, it is also a missed opportunity to do more. Senator Elizabeth Warren of Massachusetts would prefer brokers be held to a real fiduciary standard and considers the “best interest” verbiage to be a watered-down version of what would otherwise be an effective regulation.
Furthermore, the standard only requires that brokers disclose the information. Notably, it does not mean they are precluded from making recommendations that cut against their clients’ best interests.
How Does This Affect You?
Generally speaking, if Regulation Best Interest changes your relationship with your broker or advisor, you do not have to do anything. It is their responsibility to present you with Form CRS, which informs you about the scope of their work for you. But just because you will have it all spelled out for you, it does not mean you should just sit back and relax — especially if you are seeking a new broker.
It is always prudent to do a little homework to make sure things are as you need them to be:
- Read the Form CRS. As noted above, unpacking the information laid out in this document can be unpleasant, to say the least. But it is important to really study its contents so you can fully understand your relationship with your broker — and therefore their approach to financial recommendations.
- Look into the advisor’s registration. Knowing whether your candidate advisor is registered with a federal institution like the SEC or a private one like the FINRA will tell you a great deal about the services they provide. You can look up this information on the Investment Advisor Public Disclosure site or on BrokerCheck.
- Ask a friend or colleague. Word of mouth is a powerful form of recommendation. If you are uncertain about the information you encounter about an advisor, ask a trusted friend for a sense check. They might just have some perspective or insight that you would find helpful.
The bottom line for Regulation Best Interest is that its goal is to help retail investors. The distinctions between different types of financial service providers can be confusing, but it is important to know who you are dealing with. They each are governed by distinct sets of policies and procedures, and some are more likely to be aligned with your financial best interest than others.
At Succession Resource Group, we understand that you want to get the most out of your financial services. Our team of professionals has decades of experience providing individuals and businesses alike with the guidance they need to meet their goals. Contact us today for a consultation.