Proposed SEC Regulation: Enhancing Investor Protection with "Regulation Best Interest"

Basics

In a significant move to enhance investor protection, the Securities and Exchange Commission (SEC) has unveiled a new regulation aimed at revising the existing standards for brokers and investment advisors. Termed "Regulation Best Interest," this proposed rule package has recently undergone a crucial development.

On April 18, 2018, the SEC voted 4-to-1 in favor of releasing the regulation, marking a pivotal moment in investor safeguards. The commission has initiated a 90-day public comment period, encouraging stakeholders and the public to contribute their insights and opinions. This regulatory update builds upon prior efforts to fortify investor rights. Notably, the U.S. Department of Labor previously required brokers, agents, and advisors to adhere to a higher fiduciary standard when providing counsel on retirement investments. The SEC's commitment to improving investor protection through regulatory measures remains steadfast, with the proposed Regulation Best Interest serving as the latest milestone in this ongoing endeavor.

Evolving Standards

A paradigm shift occurred with the introduction of the fiduciary rule, altering the standards to which brokers were held. Previously, brokers operated under the "suitability standard," which permitted them to recommend merely suitable investments rather than truly aligned with their clients' best interests. This leniency enabled brokers to advocate for expensive investments that yielded higher commissions as long as they met the suitability criteria.

Recognizing the need for change, the Securities and Exchange Commission responded to calls for action on the fiduciary issue. Both former Chair Mary Jo White and current Chair Jay Clayton expressed a keen interest in reform. The urgency for regulatory reform further intensified when a federal appeals court panel struck down the Department of Labor's fiduciary requirement in March.

Initial assessments by experts indicate that the Best Interest Regulation, spanning over 1,000 pages, appears to be less stringent compared to the Labor Department's rule. However, it encompasses a broader scope as it extends beyond retirement investments, ensuring a more comprehensive approach to investor protection.

Enhancing Investor Protection: Key Elements of the SEC Proposal

As part of their commitment to safeguarding investors, the Securities and Exchange Commission has introduced a comprehensive proposal encompassing three essential components. These components, as outlined by the SEC, aim to foster transparency and elevate the standard of care in the financial industry:

1. Acting in the Best Interest: Under the proposal, broker-dealers would be obligated to prioritize the best interest of their retail customers when offering investment recommendations. This would ensure that the advice provided is tailored to meet the specific needs and goals of individual investors.
2. Clarifying Fiduciary Duty: The SEC aims to bring clarity to the fiduciary duty that investment advisors owe to their clients. By establishing clearer guidelines, investors can have greater confidence in their advisor's commitment to acting in their best interest.
3. Enhancing Disclosures: Investment professionals would be required to provide a brief and informative document called a customer or client relationship summary (Form CRS). This disclosure would outline the scope and terms of the client-professional relationship, enabling investors to make more informed decisions. Additionally, the proposal seeks to prohibit broker-dealers from using the word "advisor" in their name or as a title. This measure upholds the current higher standard of conduct for investment advisers, distinguishing their role from that of broker-dealers.

The SEC's proposal represents a significant step toward bolstering investor protection, fostering greater transparency, and promoting a higher standard of care within the financial industry.

Fiduciary vs. Best Interest

The financial landscape witnessed a significant development with the implementation of the fiduciary rule during the Obama administration. Drafted over a span of six years, this rule imposed a fiduciary standard on financial professionals handling clients' retirement funds.

Under the fiduciary standard, financial professionals were required to charge reasonable fees and were prohibited from making misleading statements regarding investments, payment arrangements, or conflicts of interest. In some instances, state-level regulators interpreted the rule as banning sales contests that incentivized brokers to prioritize high-fee policies over more cost-effective alternatives with comparable performance.

While consumer advocates and investor groups express skepticism regarding the extent of reform offered by the SEC's current proposal, interest groups representing the financial services and insurance industry have opposed both the fiduciary standard and similar propositions. Their contention lies in the proposal's heavy reliance on disclosures, alongside the lack of a clear definition for the "best-interest standard."

Critics further argue that disclosing conflicts of interest, as proposed in Form CRS, does not eliminate them. Additionally, the new standard of conduct fails to address sales quotas and compensation practices that incentivize brokers to recommend high-fee, low-yield investments that do not align with their clients' best interests.

Commissioner Kara M. Stein was the sole dissenting vote, expressing her disappointment in the missed opportunity to prioritize investor interests. According to Stein, the proposed regulation merely reinforces brokers' suitability obligations and mandates a few disclosures without truly advancing investor protection.

Financial Advisers' Take on the Ongoing Debate

Amidst the ongoing debate over financial standards, financial advisers, largely adhering to the fiduciary standard, express satisfaction with the public discourse. They believe that this increased visibility of various standards of conduct benefits consumers, leading to higher awareness.

Steve Sivak, CFP® and founder of Innovate Wealth, along with Dan Danford, CFP® and CEO of Family Investment Center, both Certified Financial Planners ™, emphasize the importance of the fiduciary standard. They point out that thousands of advisers commit to upholding the genuine fiduciary standard by acquiring a certification and accepting the CFP® designation, which surpasses the level of "best interests" mandated by the SEC's proposal.

David Rae, CFP®, AIF®, President and Founder of DRM Wealth Management, echoes the concerns of his colleagues, asserting that the proposal falls short of establishing a true fiduciary standard. He believes that this approach will only confuse the public and ultimately harm individual investors.

The consensus among these financial advisers is that the revised agency standards proposed by the SEC do not offer adequate consumer protection. Instead, they argue that the Regulation Best Interest proposal introduces more confusion and fails to provide the necessary clarity required for consumers when making financial decisions.

Conclusion

The SEC's proposed Regulation Best Interest represents a significant step towards enhancing investor protection and improving the quality of financial advice. The proposal includes key elements such as requiring broker-dealers to act in the best interest of their customers, clarifying the fiduciary duty of investment advisors, and enhancing disclosure requirements. While financial advisers largely support the ongoing debate surrounding financial standards, there are concerns that the proposed regulation falls short of establishing a true fiduciary standard and may confuse the public. Striking a balance between regulatory measures and market dynamics is crucial to prioritize investor interests and promote transparency in the financial industry.