Enter ‘Regulation Best Interest’
After many years of allowing brokers to operate under the suitability standard of care, the SEC has moved to strengthen it. But despite the urging of many, the result did not place brokers under a fiduciary standard. Instead, the agency adopted a new “best interest” standard, which became effective June 30, 2020. Under this new “Regulation Best Interest” or “Reg BI” standard, brokers are now required to act in a retail customer’s best interests when making a recommendation and not put their own interests ahead. Thus obligated, brokers must:
1. Provide certain disclosures about their recommendations, as well as their relationship with the customer, in a timely manner;
2. Exercise reasonable diligence, care and skill in making their recommendations;
3. Have appropriate written policies and procedures to address conflicts of interest; and
4. Have appropriate written policies and procedures to ensure compliance with Reg BI.
Reg BI does impose stricter obligations on brokers than the suitability standard, but it falls short of fiduciary rigor. Perhaps most important, while the new standard requires brokers to act in the best interests of their customers, this requirement applies only at the point of a particular recommendation and does not apply continuously.
Now, when registered investment advisors explain the advantages they enjoy with the fiduciary standard, they will be met by brokers saying that they, too, are subject to something similar-sounding—a “best-interest” standard. RIAs already challenged to show their claim over the high ground will be even more challenged when the difference is less discernible. If consumers were confused before the advent of Reg BI, we can expect them to be even more so now.
That means RIAs should focus more than ever on differentiating themselves through their services, people, platforms, fees and overall client-centric approach. Their arguments about their legal advantages should shift so they demonstrate their knowledge of their legal standard of care, emphasizing the scope of advice they offer in the new regulatory framework.
Under the paradigm that became effective in June, RIAs can argue that:
1. Brokers have some level of legal parity with RIAs at the time a specific recommendation is made, but only RIAs are required to continuously act in the best interests of their clients.
2. While RIAs focus on continuous advice, brokers are focused on sales, with advice being incidental to the sales activity.
3. RIAs are subject primarily to governmental regulation, while brokers are subject primarily to self-regulation.
Putting it all together, registered investment advisors can argue that they are best for clients who seek continuous, in-depth advice that’s always supposed to be in the client’s best interests and for clients who feel more comfortable with an advisor directly regulated by the government. In fairness, RIAs should also be prepared to acknowledge those legal points for customers who are primarily looking for help buying and selling securities and people who are less concerned about who regulates their service provider.
And this leads us back to what remains, and has always been, the greatest and clearest differentiator of all: culture. Brokers generally remain salespeople and work in a sales model. RIAs generally operate from and within a culture of advice. Yes, there are exceptions on both sides, but the advent of Reg BI isn’t likely to change a business’s overall philosophy and culture that much. RIAs that seek to set themselves apart from brokers need to remind themselves why they operate within the RIA model and not the broker model. Then they need to remind their clients, prospects and everyone else as well.
Michael J. Nathanson, JD, LLM, is chairman and chief executive officer of the Colony Group.