Brokerages sound off on Regulation Best Interest

Cracked concrete wall with rule word on and blue sky outside

Small-brokerage executive expresses concern over lack of specifics about what is 'best,' given an inability to make perfect investment choices for every client.

An executive at a small brokerage firm expressed concern Friday that the Securities and Exchange Commission’s pending advice-reform rule is too vague and could lead to an exclusive focus on the price of investments.

The centerpiece of the package is Regulation Best Interest, which is supposed to raise the standard of care for brokers. The final rules could be released within the next two to three weeks, according to a recent report in Politico.

The problem Robert Muh, chief executive of Sutter Securities, has with the measure is that it doesn’t provide details on what acting in a client’s best interest means.

“I have not been a fan of Regulation Best Interest … because it’s seeking perfection,” he said at the Financial Industry Regulatory Authority Inc. annual conference in Washington.

A manager looking at a portfolio will have no rubric for determining whether the investments were best for the client, according to Mr. Muh.

“I was hoping we would get specifics,” he said. “We’re not going to be able to judge whether that truly was at that point in time in the best interest of the client. To say it’s in the best interest is going to take time and it’s going to be based on performance.”

Selection of low-cost investments will become the primary way to ensure compliance with a best interest standard, Mr. Muh said.

“That can’t be the only measure, and I don’t think it’s going to be easy to convince people that other factors play an important role,” he said.

Under the Reg BI proposal, a broker must disclose and eliminate or mitigate conflicts of interest, such as financial incentives to sell certain investment products.

That could lead firms to take some investments off their platforms to avoid conflicts, according to Norman Ashkenas, senior vice president and chief compliance officer at Fidelity Brokerage Services.

“There is a concern some firms may limit what’s on the platform so that the universe is narrower as opposed to being able to talk to the investor and say, ‘This is what we’re providing advice about, there are other things on the platform,’” he said.

Determining whether a conflict can be eliminated is subjective and will put a premium on oversight of brokers, according to Evan Charkes, associate general counsel and managing director at Bank of America.

Supervision “is the primary mitigator,” he said. “What Reg BI is ultimately going to do is sharpen and enhance the supervisory model.”

Hillary Sale, professor of law at Georgetown University and a Finra board member, said disclosure of conflicts has proven to be ineffective in preventing investor harm.

The final Reg BI is likely to require brokers to go beyond disclosure, but will allow them latitude either to eliminate or mitigate conflicts. Ms. Sale encouraged the Finra audience to choose the former.

“You should start there before you go to mitigation and disclosure,” she said. “In the end, what you want is happy, long-term clients, and you’re not going to get them if you don’t think about it from their perspective.”

Anticipation about the final Reg BI rule is running high.

“This is a critical time for the regulation of brokers,” said Robert Colby, chief legal officer at Finra.