How advice standards have converged 3 years into Reg BI

While the SEC is working to put teeth into Regulation Best Interest, questions remain about how it’s working in practice.

The SEC implemented Regulation Best Interest in June 2020 amid a fierce debate about how the new broker-dealer standard of conduct would stack up against fiduciary duty, the standard investment that advisors must meet.

As Reg BI turns three years old, the Securities and Exchange Commission says that the two standards are converging.

“Both Reg BI for broker-dealers and the IA fiduciary standard for investment advisers are drawn from key fiduciary principles that include an obligation to act in the retail investor’s best interest and not to place their own interests ahead of the investor’s interests,” the SEC states in a staff bulletin released in late April. “Although the specific application of Reg BI and the IA fiduciary standard may differ in some respects and be triggered at different times, in the staff’s view, they generally yield substantially similar results in terms of the ultimate responsibilities owed to retail investors.”

Although delivered in innocuous regulatory speak, that statement is starting to provide clarity around what the SEC expects from all financial advisors when they recommend investment strategies and products to clients.

It comes from an agency that has different leadership than the one that approved the final Reg BI. In 2020, the commission had a 3-2 Republican majority. Under Chair Gary Gensler, it now has a 3-2 Democratic majority.

Democrats tend to promote fiduciary duty as the superior investor-protection standard, while Republicans generally led the charge in favor of Reg BI, but nevertheless, a Democratic SEC is promoting the idea that there’s not much daylight between the standards.

It’s a message that fiduciary advocates continue to dispute.

“Two years of Chair Gensler has resulted in pushing fiduciary back instead of forward,” said Knut Rostad, president of the Institute for the Fiduciary Standard. “We’re going back in time to erase the line between investment advice and product sales.”

In an April interview with InvestmentNews, Gensler said there are a lot of similarities between the separate laws that govern brokers and advisors: the Securities Exchange Act of 1934 and the Investment Advisers Act of 1940, respectively.

The most recent SEC guidance on Reg BI concentrated on the duty of care that brokers and advisors owe to their clients. The document, which was presented in Q&A format, drills down on how brokers and advisors must consider “reasonably available alternatives” when making recommendations.

It emphasizes that the obligation cannot be fulfilled through disclosure alone.

That point is key to raising the bar for the broker advice standard. Former SEC Chair Jay Clayton, who led the commission in adopting Reg BI in 2019, maintained that it was a higher standard than the previous suitability rule that governed brokers.

THE COMPLIANCE QUESTION

After taking the SEC helm in 2021, Gensler left Reg BI in place. Since then, the SEC has released several staff bulletins that outline how brokers can comply with the measure.

Gensler stressed that brokers must assess other potential ways to meet a client’s financial needs when making recommendations. Considering less costly products and strategies should be part of the process.

“It’s not just a check-the-box thing,” Gensler said. “You’ve really got to consider alternatives. It’s not the old suitability standard either.”

That emphasis draws closer together the SEC’s standard broker and advisor conduct, said Parham Nasseri, vice president of product and regulatory strategy at InvestorCom.

“The SEC is saying whether you’re a B-D or on the IA side of the house, we expect you to compare costs and reasonably available alternatives,” Nasseri said.

But questions remain about how Reg BI is working in practice.

Kate McBride, founder and president of FiduciaryPath, a fiduciary certification and training firm, said it’s still too early to tell. One of the murky areas is how the care obligation applies to brokers and what it means to consider reasonably available alternatives.

“That needs more clarification,” McBride said. For instance, it’s not clear to what extent brokers must look beyond their own firm’s product menu to satisfy the requirement to shop around for alternative recommendations.

“The firm is going to have the lineup it has,” she said. “I’m not sure how you go outside the firm.”

In the three years since Reg BI went into force, the SEC has brought only one substantive enforcement case citing violations of the rule. Some critics said that action could have been brought just as readily under the suitability rule and that it hasn’t provided any insight into how Reg BI is changing advice standards.

Rostad said the SEC has missed chances — through enforcement and its guidance documents — to demonstrate how Reg BI requires more than disclosure of conflicts of interest.

“I think that’s a fantastic goal,” Rostad said. “When I see examples that [Gensler] is doing that, I’ll be the first to applaud the chair.”

EXPANDING THE DEFINITION

While the SEC is working to put teeth into Reg BI, work continues elsewhere on investment-advice policy. The Department of Labor is expected soon to promulgate another iteration of its advice standard for retirement accounts. Observers anticipate the DOL’s proposal will expand the definition of who is a fiduciary when working with retirement savers.

Meanwhile, many states have approved an annuity suitability rule developed by the National Association of Insurance Commissioners. That measure is meant to ensure that insurance professionals are acting in their clients’ best interests when recommending annuities, a product that can be complex and costly.

The advent of Reg BI and the adoption of the annuity suitability rule by about two-thirds of the states create a regulatory environment for advice standards that’s very different from what it was in 2016, when the DOL promulgated its original fiduciary rule, said Brad Campbell, a partner Faegre Drinker Biddle & Reath.

With the SEC and NAIC measures that focus on serving the best interests of clients, Campbell wonders what the DOL would accomplish by proposing another rewrite of fiduciary regulation.

“This is a rule that’s in response to something that’s not an issue,” said Campbell, an assistant secretary of labor in the George W. Bush administration. Revisiting the fiduciary rule “strikes me as something that should be very low on their priority list.”

McBride wants DOL to move forward with the next iteration of its fiduciary rule.

“They know what they need to do for better outcomes for [retirement] plan participants,” McBride said. “People need to retire. The DOL understands what’s at stake here.”

The stakes are also high for brokers and investment advisors as they work to comply with advice standards that remain a work in progress.

The most recent SEC staff bulletin on Reg BI suggests that some firms are falling short in showing that their recommendations are in their customers’ and clients’ best interests, Nasseri said.

Even though the guidance doesn’t create new obligations under Reg BI, firms should follow it to ensure compliance and keep the SEC from their doors when it ramps up enforcement of the rule.

“Do you speed until the cop pulls you over?” Nasseri said. “Or, for everyone’s best interests, do you slow down?”

Regardless of how fast financial firms are complying with evolving advice standards, it looks as if regulators are trying to make sure they end up in the same place.