SEC Proposes "Regulation Best Interest" Increasing the Obligations Owed by Broker-Dealers and Investment Professionals to Their Retail Customers

Financial Institutions Law Alert

The SEC on Wednesday proposed a set of rules seeking to clarify and strengthen duties and obligations owed to retail customers by broker-dealers and investment professionals. Under the heart of the proposal, Regulation Best Interest, a broker-dealer “has a duty to act in the best interest of the retail customer at the time the recommendation is made, without putting the financial or other interest of the broker-dealer ahead of the retail customer.” While the proposal does not define “best interest,” it does set forth ways in which a broker-dealer could meet its duties.  

The SEC specifically notes that the duty is discharged through three specific obligations – (i) disclosure of key facts about the relationship; (ii) the exercise of reasonable diligence to understand the product, have a reasonable basis to believe the product is in the retail customer’s best interest, and have a reasonable basis to believe that a series of transactions is in the retail customer’s best interest; and (iii) disclosure of conflicts of interest, and the maintenance and enforcement of policies and procedures pertaining to such conflicts.

The proposal also includes an interpretation of the standard of conduct for investment advisers. Notably, the rule would prevent brokers from using the title investment advisors, given the additional requirements that come with that formal title. Specifically, the Commission observed that the fiduciary duty of investment advisers is different from the proposed obligations under Regulation Best Interest. Thus, Regulation Best Interest maintains the historical delineation between the different obligations of investment advisers and associated persons.

Lastly, the SEC proposed a requirement for investment advisers, broker-dealers and associated persons to provide their retail clients with a new standardized summary of their relationship through Form CRS.  The focus of the new summary would be increased disclosure and transparency of conflicts information, and the nature of the investment professional’s role -- including restrictions on an associated person’s use of terms such as adviser because of its similarity to “investment adviser,” which creates confusion for customers.  The new summary would also require retail brokers to clearly explain the fees and commissions when giving financial advice.

Proposed Regulation Best Interest is already drawing criticism. Democratic Commissioner Kara Stein, who voted against the proposal because of its failure to institute a fiduciary standard for broker-dealers, stated of the rules, “One might say that the emperor has no clothes.”  By contrast, Republican Commissioner Michael Piwowar said the proposal could be improved by better explaining what brokers must do to show their advice was in their clients’ best interest, calling the lack of clarity “worrisome.”  There is a 90-day public comment period, so we expect that proposed Regulation Best Interest will be revised.  However, in light of the uncertainty surrounding the ultimate fate of the Department of Labor’s fiduciary rule now that it has been struck down by the Fifth Circuit, broker-dealers and investment professionals should expect to find themselves having to comply with a new elevated standard of conduct at some point in the not too distant future.