The introduction of Regulation Best Interest (Reg BI) by the SEC has major implications, both good and bad, for registered investment advisors (RIAs) and broker-dealers). Affecting both parties, the goal is to develop an overall understanding and initiative to provide recommendations in the best interest of clients. Here we will discuss the intended consequences and the possible unintended consequences which may, in some ways, actually adversely affect the end client.
Overview Of Reg BI
According to FINRA, the SEC’s Regulation Best Interest (Reg BI) “establishes a best interest standard of conduct for BDs and associated persons when they make a recommendation to a retail customer of any securities transactions or investment strategy involving securities, including recommendations of types of accounts.” The primary change under Reg BI is that the SEC now requires BDs and RIAs to fill out a “Form CRS” containing an obligation to explain the nature of their relationship and services, fees and costs, and their conflicts of interest and standard of conduct.
With that said, state regulators will be monitoring the adjustments made by firms with respect to the requirements set out under Reg BI.
In summary, Reg BI has four main mandated components that BDs and SEC registered RIAs must comply with, according to an article by securities attorney Scott Furst, which include:
· Introduction
· Relationship and services
· Fees, costs, conflicts and standard conduct
· Disciplinary history
Benefits Of Reg BI For Retail Investors
The major benefit for retail investors under Reg BI is the fact that it goes the extra mile in an attempt to protect clients by requiring disclosure and aims to ensure a product is really in their best interest.
In terms of conflicts of interest, a 2019 survey showed that “41% of firms had no policies or procedures, 70% had no internal enforcement committees or officers and 76% didn’t have any conflict registers identifying them in detail,” according to recent surveys by NASAA.
However, Andrea Seidt, chair of a Reg BI implementation committee mentioned that it “will likely cause some BDs to stop selling the more complex products” according to an article by Tobias Salinger, which can actually be seen as a major downside of Reg BI. More complex products are not for everyone, but in reality, they can be of great value to many clients.
Shortfalls Of Reg BI For RIAs And BDs
Although Reg BI was primarily implemented to raise the standards of conduct for BDs, there may be subsequent shortfalls that lead to a reduction in quality product offerings due to the series of regulatory hoops that BDs must jump through. Have the regulators shot themselves in the foot by actually making it harder for advisors to offer access to quality alternative investments?
For example, BDs and RIAs are now required by the SEC to put together two-page relationship summaries, called a Form CRS, for every retail client. You can imagine how much time is spent on regulatory issues for BDs and RIAs who are already wearing multiple hats trying to best serve their clients. In fact, it is estimated that “each advisor will spend an average of 23.77 hours and over $6,000 to build the form,” according to an article about Form CRS by Colin Ward. So now the question is, could the burdensome paperwork of Form CRS, primarily the requirement of providing fees, costs, and product structures, lead to simpler “plain vanilla” investment strategies and product offerings?
This is especially worrisome as we see the historical 60/40 portfolio structure struggle even further due to low bond yields and diversification issues, while the alternative investment space gains traction. In an ideal world, we should be encouraging the use of high-quality alternative investments that can add significant value to an individual’s portfolio and lower equity market correlation. That is truly in their best interest. But in reality, Reg BI might just encourage advisors to do the opposite – stray away from alternative investments in an attempt to comply rather than create opportunity. This will likely hurt the smaller RIAs and BDs more than others because of their inability to automate regulatory processes under Form CRS and the additional time burden this places on them.