The Securities and Exchange Commission (SEC) voted 4-to-1 on April 18, 2018 to release a new regulation that would revise agency standards for brokers and investment advisors. The proposed rule package, called Regulation Best Interest, was opened for a 90-day public comment period.
This is the latest step in a historical attempt to improve safeguards for investors. Previously, the U.S. Dept. of Labor established a requirement that held brokers, agents and advisors to the higher fiduciary standard when advising clients on retirement investments.
Please note that Investopedia refers to investment professionals with a strict fiduciary responsibility who advise clients and/or manage their financial assets as “advisers.” We refer to investment professionals who follow the suitability standard as “advisors.”
Before the fiduciary rule, brokers were only held to the “suitability standard.” This meant that when brokers advised their clients, they only had to recommend investments that were suitable, but not necessarily in their clients' best interest. Brokers could recommend expensive investments that paid them a higher commission as long as they were considered suitable.
The SEC had been called on to act on the fiduciary issue, and both the previous chair, Mary Jo White, and the current one, Jay Clayton, had indicated interest in reform. When the Department of Labor’s fiduciary requirement was struck down by a federal appeals court panel in March, the need for reform was heightened.
According to experts, initial readings of the 1,000 page Best Interest Regulation suggest that it is less strict than the Labor Department’s. In one sense, however, it’s broader because the regulation is not limited to retirement investments.
The SEC Proposal
The proposal is divided into three parts. According to the SEC:
- Broker-dealers would be required to “act in the best interest” of their retail customers when making investment recommendations.
- The “fiduciary duty that investment advisors owe to their clients” would be clarified.
- Investment professionals would be required to provide a new short-form disclosure document, called a customer or client relationship summary (Form CRS), that reveals “the scope and terms of the relationship.” In addition, broker-dealers would be banned from using “advisor” with their name or as a title. This would uphold the current higher standard of conduct for investment advisers compared to broker-dealers.
Fiduciary vs. Best Interest
The fiduciary rule, drafted over a six-year period during the Obama administration, held financial professionals to the fiduciary standard when handling their clients’ retirement money.
This meant they had to charge reasonable fees. They were not allowed to make misleading statements about investment transactions, how they were paid, or any conflicts of interest. Some state-level regulators in Massachusetts also read the law as banning sales contests designed to encourage brokers to sell high-fee policies to clients over cheaper ones that perform just as well.
While consumer advocates and groups representing investors are skeptical that the SEC’s current proposal offers any significant reform, interest groups representing the financial services and insurance industry have opposed the fiduciary standard and similar proposals. They say the proposal relies too heavily on disclosures and fails to clearly define “best-interest standard.”
Critics also point out that disclosing conflicts of interest in documents, such as the proposed Form CRS, is not the same as eliminating them. In addition, the new standard of conduct fails to challenge sales quotas and other compensation practices that lead brokers to put their clients into high-fee, lower-yielding investments that are not in their best interest.
SEC Commissioner Kara M. Stein was the only dissenting vote. Stein said, “... unfortunately [the proposal] squandered the opportunity for us to act in the best interest of investors.” According to Stein, the proposed regulation, “reaffirms that broker-dealers have to meet their suitability obligations,” and merely, “requires and mandates a few disclosures.”
Financial Advisers Respond
Regardless of the outcome, many financial advisers—a group that largely adheres to the fiduciary standard—are pleased about the public debate. Ultimately, consumers benefit from the greater visibility of the different standards of conduct to which financial professionals must adhere.
“This momentum is good. ‘Fiduciary’ and ‘best interest’ are being debated by the government, and this is increasing consumer-awareness,” says Steve Sivak CFP®, founder of Innovate Wealth in Pittsburgh, Penn. Sivak and Dan Danford CFP®, principal and CEO of Family Investment Center, are both Certified Financial Planners ™ (CFP®) and members of Advisors Insights, Investopedia’s network of financial advisers.
According to Danford, thousands of advisers agree to hold to the high standards of a genuine fiduciary by pursuing the certification and accepting the CFP® designation. That is not the level of “best interests” required by the new SEC proposal.
“This is not a fiduciary standard. This is just a better-dressed suitability standard,” says David Rae CFP®, AIF®, president and founder of DRM Wealth Management and member of Advisor Insights. “This proposal will create more confusion for the public and, in the end, individual investors will be the ones who are hurt.”
Sivak believes that the revised agency standards are not enough to protect consumers: “If you bury important information in disclosures, that will only add more confusion for a consumer who’s shopping for services. Instead of clarifying lines, the SEC’s Regulation Best Interest proposal blurs them.”