Independent broker-dealers face a number of cross-currents in the year ahead, ranging from merger madness and the opening of private markets to competitive recruiting costs and investor data protection. And oh yes, Reg BI is coming. Take a look at some developments that may matter in the IBD space.
1.Reg BI implementation looms for independent broker-dealers
No regulatory deadline has dominated the compliance landscape in recent memory like June 30, the date when the Securities and Exchange Commission’s Regulation Best Interest must be implemented.
Reg BI is meant to raise the broker standard above the current suitability requirement. It comes with many new disclosures, including a customer relationship summary, known as Form CRS.
Now that Reg BI is looming, the effort the brokerage industry put into getting ready for the vacated Labor Department fiduciary rule is paying dividends.
“Our members have a lot of work ahead of them to ensure compliance with Reg BI,” said David Bellaire, executive vice president and general counsel at the Financial Services Institute, a trade association representing independent brokers and financial advisers. “But they had a good head start with the fire drill surrounding the DOL rule.”
2. Brokerage industry wants to stop state fiduciary rules
Before the SEC’s Regulation Best Interest is implemented, it may have a couple of competitors at the state level – an outcome the brokerage industry is trying to stop.
Massachusetts, New Jersey and Nevada are all working on their own regulations that would impose a fiduciary standard of care for financial professionals in those states. It’s not clear which state will cross the finish line first, but the Massachusetts and New Jersey rules are nearing the final stage.
Massachusetts Secretary of the Commonwealth William Galvin said he is moving ahead with a state-level rule because Reg BI doesn’t offer strong enough investor protections.
Brokerage firms and industry trade associations are urging the states to stand down and let Reg BI serve as the national advice standard.
“Secretary Galvin is a true believer in his proposal, and we suspect Massachusetts is going to move forward rather quickly, so we’re considering our options,” said David Bellaire, executive vice president and general counsel at the Financial Services Institute, a trade association representing independent brokers and financial advisers.
3. Brokers raise concerns over collection of investors’ information for market surveillance
As regulators move toward creating a market surveillance system designed to help them quickly detect disruptions and potential investor harm, brokerages are raising concerns about the vulnerability of the data housed in the mechanism.
The so-called Consolidated Audit Trail would capture data on customers and orders for exchange-listed equities and over-the-counter securities across all U.S. markets. It is scheduled to be implemented in 2022, while the transactions database will go into operation this year.
Brokers are worried that the CAT will become a treasure trove for hackers seeking investors’ personally identifiable information. They also are concerned that they’ll be held liable for such breaches.
SEC Chairman Jay Clayton maintains that the CAT can operate without exposing sensitive investor information.
But skeptics say regulators haven’t offered details on what they will and won’t collect.
“Retail personally identifiable information needs to come out of the CAT,” said Christopher Iacovella, chief executive of the American Securities Associations, which represents regional financial services firms. “This is the epitome of what’s wrong with the administrative state.”
4. SEC wants to open private markets to more ordinary investors
Now that major investment advice reform is on the books, SEC Chairman Jay Clayton is turning toward the private markets.
One of Mr. Clayton’s goals is to give ordinary investors more opportunities to buy unregistered securities, or private placements. In several public appearances over the last year, he has cited the fact that large pensions can invest in private funds but investors in defined-contribution plans, such as a 401(k) or an individual retirement account, cannot. He argues this restriction is keeping them from realizing gains.
In the first move to relax private-market restrictions, the SEC proposed changes to the accredited investor standard late last year, allowing more people to qualify for private placement purchases based on professional licenses they hold or special knowledge they’ve acquired.
Critics assert the SEC doesn’t understand potential investor harm from participation in private markets. Brokerages must balance that possibility with the revenue opportunities that more private placement sales could bring.
5. LPL to focus on employee broker-dealer
LPL Financial, the largest broker-dealer that works with independent contractor advisers, raised some eyebrows last year when it said it was acquiring a B-D for employee reps, Allen & Co. With the growth of the registered investment adviser as a business model, wasn’t LPL taking a step backward by chasing such employee brokers?
The firm wants to broaden its appeal and offer a platform for a variety of advisers, including employees, who get a lower payout but receive better benefits. Look for LPL to attempt to recruit and offer attractive bonuses to advisers who want to remain employees.
6. IBD recruiting will continue to get more expensive.
Speaking of recruiting and LPL, in 2019 the largest IBD infuriated its competition by offering recruits fat deals to jump to LPL. So far, no direct, tit-for-tat recruiting war has broken out among the largest IBDs, which historically pay far less in recruiting bonuses than other broker-dealers because their advisers receive a higher overall payout. But LPL will continue to put its foot to the floor when it comes to recruiting, driving up the cost for its competition.
7. RIA networks will eat away at IBD market share.
But the bigger worry for large IBDs will be the increased competition from large networks of registered investment advisers. Last year’s acquisition of United Capital by Goldman Sachs underscores the gold rush occurring in the financial advice industry right now; private equity investors see better returns on investment from RIAs, and with lower profit margins and higher costs of regulation than RIAs, IBDs will lose advisers to this fast growing segment of advisers.
8. Investor complaints against IBDs over sales of private placements to spike
2019 saw investment manager GPB Capital struggle mightily. Since 2013, the firm sold $1.8 billion of high-commission private placements through 60 IBDs. The company has faced investigations from the FBI and the Securities and Exchange Commission, and thousands of investors, many of them elderly, at the moment don’t know the value of their investments. IBDs will be hammered this year by lawsuits in the form of arbitration complaints filed on behalf of these investors by plaintiffs’ lawyers.
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