SEC Imposes New Standard for Broker-Dealer Investment Advice

On June 5, 2019, the Securities and Exchange Commission (“SEC”) voted to adopt “Regulation Best Interest,” which is intended to increase the duties a broker-dealer owes to its clients. While SEC-registered investment advisors (“RIAs”) have historically been held to a fiduciary duty standard of care, broker-dealers have been subject to the lesser “suitability” standard. Governed by FINRA Rule 2111, the suitability standard requires that a broker-dealer have a reasonable basis to believe a recommended transaction or investment strategy is suitable for the customer based on the customer’s investment profile. The customer’s investment profile includes factors such as the customer’s age, financial situation, and investment experience. Consumer advocates had hoped the SEC would eliminate the distinction between the duties owed by RIAs and broker-dealers by establishing an across-the-board fiduciary standard covering both. While the SEC has stated that the “best interest” standard “draws from key fiduciary principles,” supporters and critics alike agree that it falls short of the fiduciary duty standard.

So what exactly is the “best interest” standard? According to the SEC’s press release, “When making a recommendation of a securities transaction or an investment strategy involving securities, a broker-dealer must act in the retail customer’s best interest and cannot place its own interests ahead of the customer’s interests.” The best interest standard “applies to account recommendations, including recommendations to roll over or transfer assets in a workplace retirement plan account to an IRA, and recommendations to take a plan distribution. It also applies to implicit ‘recommendations to hold’ that result from agreed-upon account monitoring.” The new regulation also requires broker-dealers to provide additional disclosures about the broker’s fees and scope of services provided, as well as mitigate potential conflicts through disclosure of any financial incentives the broker-dealer has to sell specific products.  

Whether the best interest standard ultimately provides greater protections to consumers, as supporters hope, remains to be seen. Critics of the new regulation anticipate litigation and additional regulatory guidance given what they describe as the ambiguity and vagueness of the regulation. There also remains some question about how the standard will be enforced to hold brokers to the standard. Though the regulation is intended to have an impact on day-to-day interactions with investors, the immediate concern for many broker-dealers is the revision of disclosures and marketing materials, as well as updates to compliance systems. The new rules become effective 60 days from publication in the Federal Register and broker-dealers must begin complying with Regulation Best Interest by June 30, 2020.