A Long Time in the Making, SEC’s Regulation Best Interest Raises the Bar for Investor Protection

The concept of a heightened standard of conduct for broker-dealers when providing personalized investment advice to retail investors has been studied and debated for decades. All of that is coming to fruition today – June 30 – with the SEC’s Regulation Best Interest (Reg BI) taking effect.  This new rule is robust and expansive with significant duties and obligations imposed on broker-dealers that unquestionably enhances investor protection.

A SIFMA survey of firms earlier this year found that in response firms are changing their business models, prioritizing the management of conflicts of interest, strengthening their compliance systems and procedures, and investing significant resources to prepare for the rule’s implementation.

The effort and costs to implement new regulations are substantial – under ordinary terms. The challenges to meet implementation have been magnified by the current crisis. Nonetheless, firms report making strong good-faith efforts to be in compliance on day one, consistent with SEC guidance.

Reg BI imposes a materially heightened standard of conduct for broker-dealers when serving retail clients. While principles-based, the rule is specific with respect to the duty and obligations brokers owe to their clients, and what steps they must take to comply, including the obligation to eliminate, or disclose and mitigate, certain conflicts of interest.

Under Reg BI, recommendations no longer may be just ‘suitable’ for the client (and in fact the previous FINRA Suitability requirement no longer exists), but rather they must be in the retail customer’s “best interest.” This means broker-dealers cannot put their interests ahead of the interests of the retail customer. Further, brokers will be held to this new standard under the robust examination and supervision regimes of the SEC and FINRA, as well as in FINRA’s arbitration forum.

Contrary to some commentary, the rule explicitly requires Broker-dealers to mitigate, and in some cases eliminate, financial conflicts of interest. Disclosure of a financial conflict alone also is not considered adequate.

The new rule also requires broker-dealers to exercise reasonable “diligence, care and skill” in making recommendations. These principles are the core of a broker-dealer’s “Care Obligation” in Reg BI.

The newly implemented standard – together with existing standards –  address the intended principles, goals and protections of the former DOL fiduciary rule. Reg BI applies more broadly than the DOL fiduciary rule because it applies to all retail customer accounts, not just qualified retirement accounts, and will allow the SEC and FINRA to enforce a common standard across the industry. At the same time, it avoids the many shortcomings that were embedded in the DOL rule, such as those that threatened to lead to greater cost, less choice and fewer professional services and options for retirement savers.

The totality of these new, explicit regulatory requirements necessitate brokerage firms dramatically enhance their supervisory and compliance regimes to the benefit of retail investors.

The decade-plus of advocacy and recent and ongoing compliance work are worth it to uniformly enhance investor protection to the level investors should and do expect.

Kenneth E. Bentsen Jr. is president and CEO of SIFMA, the voice of the nation’s securities industry. He is also chairman of the Global Financial Markets Association (GFMA), of which SIFMA is the U.S. regional member.

For more, visit SIFMA’s Best Interest Standard Resource Center