Michael Kitces is predicting that the rapid flow of investors and firms away from brokerages and into the advisory model will make Regulation Best Interest obsolete in the not-too-distant future.

In 2020, Kitces, co-founder of the XY Planning Network, a firm that serves 1,800 fee-for-service advisors nationwide, lost his legal battle to force the Securities and Exchange Commission to vacate its retail advice rule on the grounds that it didn’t do what Congress ordered: create a fiduciary standard for broker-dealers and their registered representatives.

“Now the irony is because the advisory model serves consumers so much better and consumers are flocking to it, all the growth is happening in the RIA model. And broker-dealers are basically reinventing themselves into the RIA model in real time anyway, because it’s just actually better for consumers and they’re voting with their feet,” Kitces said in an interview during the XY Planning Network’s mid-September conference in Atlanta, called XYPN Live.

It’s a “weird sort of irony” that in enough years of the trend, “Reg BI will largely become defunct because it will regulate a nonexistent group of broker-dealers who don’t really stick with this model,” Kitces said, noting that this all underscores the failure of Reg BI.

The number of RIAs the SEC regulates has increased by 25% in the past year, to more than 26,000 firms, while the number of broker-dealers overseen by the Financial Industry Regulatory Authority fell for the fourth straight year in 2022 to a total of 3,378.

“Why did we do all this with Reg BI reform when it hasn’t really created a meaningful change, it’s not changing the flow of consumers [away from brokerage] and clearly the problems of conflicts didn’t get solved?” Kitces asked.

Today, Reg BI’s failures are even more sharply in focus, he argued. “Firms don’t need to actually mitigate any conflicts of interest, they just need their CRS [the client relationship summary form] to disclose them more clearly. But fundamentally that is not really how fiduciary regulation should work, because some conflicts don’t get well mitigated, and disclosing them doesn’t actually solve the problem,” he said.

“The bigger underlying challenge to us, though, is that Reg BI has essentially created a world where broker-dealers can substantially operate on exactly the same conflicts of interest that they had all along, but the brokers are somehow expected to magically mitigate the conflicts of interest from the broker-dealer that oversees their compliance and profits by them not mitigating well. Somehow that was supposed to magically work itself out,” Kitces said.

As a result, broker-dealers who keep their disclosures up-to-date get off scot-free, he says, “but brokers who are too successful run the risk of getting punished by being found that they didn’t adhere to Reg BI. It sells out the broker to allow the broker-dealer to continue with its business model,” he added.

Free Of Conflict?
Alan Moore, co-founder of the XY Planning Network, said at the conference that he had spoken to an advisor laughing about a CRS he had seen. “It was 13 pages of just jargon with lines like, ‘Our firm has this conflict, but our advisors do not have the same conflict of interest.’ Well, they do. It’s an absolute mess. Reg BI did nothing, in my opinion, to ensure fiduciary advice,” Moore said.

Kitces said Reg BI ultimately failed to change the culture and business model practices of broker-dealers, and that has caused consumers to flee.

In deciding not to take his case against the SEC to the U.S. Supreme Court, Kitces said he would instead support state regulators pursuing more stringent fiduciary rules. He was asked if he was happy about Massachusetts’s recent win in the state’s Supreme Judiciary Court that affirmed the state’s fiduciary rule over the trading platform Robinhood.

“Yes and no,” Kitces said. “Yes, because it was important to get clarity that states can set higher standards than what Reg BI set, and I’m very curious to see if the Massachusetts ruling launches a fresh round of fiduciary efforts in 2024.”

The problem, he continued, “is that the Massachusetts approach, at the end of the day, is that if broker-dealers are providing services like advisors they should be subject to higher standards. Our view is fundamentally different. If broker-dealers start offering services that look more like advisors, they should just be required to be advisors and be regulated under the rules advisors already have. We don’t need different rules.”