SEC advice reform: What’s in the final Reg BI, Form CRS and agency interpretations

Compliance requirements in the regulatory package affect both brokers and investment advisers.

The Securities and Exchange Commission’s long-awaited investment advice reforms, which were approved June 5 in a 3-1 vote, will make the most significant changes to advice standards in more than two decades.

After receiving more than 6,000 comment letters and hosting several investor roundtables and one-on-one meetings with interested parties, the SEC has made only minimal revisions to its original proposed rules, which have been examined at length since their release in April 2018.

The SEC released a statement and fact sheet during the hearing that stated its actions “are designed to enhance and clarify the standards of conduct applicable to broker-dealers and investment advisers, help retail investors better understand and compare the services offered and make an informed choice of the relationship best suited to their needs and circumstances, and foster greater consistency in the level of protections provided by each regime.”

Only time will tell how much the agency’s final rules will accomplish these goals.

“Instead of having a uniform fiduciary standard for identical advisory services, there will continue to be two somewhat different market conduct standards to what can be identical advisory services,” said Duane Thompson, senior policy analyst at Fi360. “It’s another tangible sign that the broker-dealer business model has changed dramatically in recent years, where advice is a dominant feature of what they provide.”

Regulation Best Interest

The centerpiece of the four-part reform package is Regulation Best Interest, which SEC chairman Jay Clayton said raises the broker standard above the current suitability requirement. The SEC hearing statement said the best-interest standard cannot be satisfied through disclosure alone, and “explicitly requires the broker-dealer to consider the costs of the recommendation.” These requirements extend to any suggestions that a client roll their workplace retirement plan into and individual retirement account handled by the broker.

SEC reform fast facts

1. The Securities and Exchange Commission passed its four-part advice reform package last Wednesday in a 3-1 vote.

2. SEC chairman Jay Clayton indicated a main purpose of the rules was to help investors better understand the differing conduct standards and services of brokers and investment advisers, which will continue to be regulated separately.

3. The centerpiece of the package is Regulation Best Interest, which requires brokers to act in clients’ best interests by considering such things as costs when making product or rollover recommendations.

4. Firms must have written policies in place to eliminate some sales contests, such as those that promote particular securities, but can provide financial incentives for things like total products sold or the sale of proprietary products.

5. A client relationship summary (Form CRS) must be given by both brokers and investment advisers at the start of a client relationship that explains services, fees and conflicts, among other matters.

6. An interpretation of the investment adviser fiduciary standard was included, which clarified that while advisers are fiduciaries, not all conflicts must be eliminated and the scope of client relationships can vary.

7. An interpretation of the “solely incidental” exemption brokers can use to give advice without being an investment adviser clarifies that such advice can include the “value and characteristics” of securities and the advisability of transacting them.

8. Brokers and advisers must be in compliance with the new standards by June 30, 2020.

Other conflicts, such as contests or compensation that reward the sale of some products or a high volume of sales in general, were addressed in the language of Reg BI but not entirely eliminated. Written policies and procedures must eliminate such contests related to specific securities or types of securities, but not compensation for total products sold or asset accumulation. Broker-dealers also can offer only proprietary products or a small menu of products and use compensation to incentivize sales of these.

Form CRS

Both investment advisers and broker-dealers will be required to produce a client relationship summary at the start of the relationship. Form CRS will summarize information about services, fees and costs, conflicts of interest and the legal standard of conduct, and disclose any disciplinary history related to the firm or the adviser. A survey conducted on behalf of the SEC last fall showed that investors embraced but failed to grasp such disclosures meant to help them distinguish between investment advisers and brokers.

Language in the final rule gives some leeway to broker-dealers on their Form CRS, saying “firms are not expected to disclose every material conflict of interest, and should instead consider what would be most relevant for retail investors to know.” In a change from the proposed rule, the agency said it wanted to provide broker-dealers more flexibility in the wording used on these forms, and removed the prescribed language required in the original regulation.

Two interpretations

Finally, the SEC advice reform package includes two interpretations of current law.

The rule states that an investment adviser owes a fiduciary duty to its clients, under the Investment Advisers Act of 1940, that is principles-based and applies to the entire relationship between an investment adviser and the client. It clarifies, however, that not all conflicts need to be eliminated — some can merely be disclosed — and that the scope or ongoing nature of a client relationship may vary among clients.

Rick Fleming, the SEC’s investor advocate, said last Wednesday that the regulator’s plan “weakens the existing fiduciary standard by suggesting the liability for nearly all conflicts can be avoided through disclosure.”

Mr. Fleming added that the new broker requirements are “a step in the right direction,” but they were undermined by the SEC’s revised interpretation of the fiduciary obligation for investment advisers.

One addition to the original proposed rule package was an interpretation of the “solely incidental” exemption in the Investment Advisers Act of 1940, which allows brokers to provide some advice without requiring they register as investment advisers and become fiduciaries, but does not allow them to be compensated. The new interpretation clarifies that advice about the “value and characteristics” of securities or about transacting them is allowed in the normal course of business.

The SEC approved all four measures last Wednesday in a partisan result. Republican commissioners Hester Peirce and Elad Roisman voted with Mr. Clayton for passage, while Democratic member Robert Jackson dissented on all four measures.

Effective dates

The Reg BI and Form CRS rules will become effective 60 days after their publication in the Federal Register, and firms must be prepared to comply with them by June 30, 2020. The two interpretations are effective as soon as they land in the Federal Register. The SEC is setting up a committee to help firms meet the new requirements, and provided the following email address to direct questions during implementation: [email protected].

“The winners here are clearly the securities and insurance industries, because they prevailed in overturning the [Labor Department’s fiduciary] rule and argued that the SEC is the appropriate body to oversee those industries,” Mr. Thompson said. “But if you’re a broker-dealer, there are still big changes coming when it comes to managing and avoiding conflicts of interest.”

Bloomberg News contributed reporting to this story.

Related Topics: Securities and Exchange Commission