Regulation Best Interest (Reg BI) raises the standard of conduct that broker-dealers must meet when they provide investment advice to retail investors. Recently, however, an expanding cadre of securities regulators and self-regulatory organizations (SROs) have said that the rule does not raise the standard high enough. Now there is a trend toward imposing even higher conduct standards. Broker-dealers that are building a compliance framework around Reg BI should, therefore, treat the rule as a floor, not a ceiling.
In June, the U.S. Securities and Exchange Commission (SEC) adopted Reg BI, which builds on broker-dealers’ obligation to make only suitable recommendations to retail investors by requiring that broker-dealers also act in the “best interest” of their retail customers. For purposes of Reg BI, this means that brokers must place clients’ interests ahead of their own, consider potential risks and costs associated with recommended securities transactions or strategies, disclose certain information about the broker-client relationship, and disclose or eliminate conflicts of interest.
Importantly, while the standard of conduct established in Reg BI “draws from key fiduciary principles,” it does not establish a fiduciary standard for broker-dealers. The SEC’s decision not to impose a fiduciary standard on broker-dealers disappointed regulators and market participants who hoped that the SEC would institute a uniform (fiduciary) standard of care for broker-dealers and investment advisors. Moreover, the SEC’s failure to establish a fiduciary standard for brokers has prompted calls for state securities regulators to establish their own broker-dealer conduct standards in order to fill a perceived gap between the fiduciary standard and the lower conduct standard established in Reg BI.
In a public statement on the adoption of Reg BI, SEC Commissioner Robert Jackson stated that the rule “unequivocally … sets a federal floor, not a ceiling, for investor protection,” and invited state lawmakers to “[k]eep pushing for meaningful protections.” Since then, several securities regulators and SROs have taken action, and Reg BI now faces challenges on several fronts. Noteworthy recent developments include:
• Several states and state securities regulators are considering adopting—or have already adopted—their own, more stringent conduct standards for broker-dealers; and some will impose uniform fiduciary standards for broker-dealers and investment advisors.
• The House of Representatives passed legislation—spearheaded by House Financial Services Committee Chairwoman Maxine Waters—that amends an appropriations bill to prohibit the SEC from using its budget to implement, administer, enforce or publicize Reg BI. The amendments to the appropriations bill have been characterized as hitting “pause” on the implementation of Reg BI.
• New York Attorney General Letitia James led a coalition of eight attorneys general who sued the SEC to set aside Reg BI or prevent the agency from implementing the regulation. An investment advisors’ organization has also sued to set aside Regulation Best Interest. The court dismissed the cases for lack of subject matter jurisdiction, but an appellate court in New York is currently considering the parties’ request that it consider the SEC rulemaking.
• The North American Securities Administrators Association (NASAA) has the ability to propose a model rule that would impose a more stringent conduct standard. And NASAA has indicated that it has established an internal committee that is analyzing the SEC’s final Reg. BI rule package, and is coordinating with the SEC and Finra on interpretive issues and regulatory considerations. It is also assessing potential NASAA regulatory responses, but currently has no plans to change existing model rules or develop new ones in response to Reg. BI. Any new rules would require approval of NASAA’s Board and membership.
• The Certified Financial Planner Board of Standard (CFP Board) enacted a new Code of Ethics and Standards of Conduct that requires CFP professionals to act as fiduciaries when providing financial advice, expressly expanding on the conduct standard set out in Reg BI.
These challenges create serious questions about whether the “best interest” standard set forth in Reg BI will become the prevailing standard of conduct for broker-dealers. For industry professionals, these challenges create considerable doubt about the standard of conduct they will be expected to satisfy when the rule takes effect in June 2020. Before then, firms must figure out how to build a compliance program around Reg BI.