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SEC Approves Long-awaited Investment Advice Package

Regulatory Compliance

On June 5, the Securities and Exchange Commission voted 3-1 along party lines to put in place new standards for broker-dealers and investment advisers – including some new considerations regarding retirement plan rollover recommendations.

The lone “no” vote (on all four issues before the SEC) came from the (currently) sole Democratic Commissioner Robert Jackson, Jr., who complained that the package did not raise the standard for investment advice. “I hoped to join my colleagues in announcing that the Nation’s investor protection agency has left no doubt that, in America, investors come first. Sadly, I cannot say that,” Jackson stated. The Commissioner went on to explain that he believes the rules retain a “muddled standard” that exposes millions to the costs of conflicted advice and contended that SEC’s position “concludes that investment advisers are not true fiduciaries.”

But Chairman Jay Clayton said in his opening statement that he believes “these rules and interpretations address the obligations of broker-dealers and investment advisers when they provide investment advice and services to our Main Street investors.” 

Clayton further emphasized that the recommendations reflect a “careful study of the DOL Fiduciary Rule, incorporating certain aspects of the rule that will enhance the broker-dealer standard of conduct in line with reasonable investor expectations, while avoiding other aspects of the rule that appear to have been primary drivers of the rule’s unintended consequences, such as the introduction of a best interest contract exemption and private right of action, and the uncertainty of whether, and if so to what extent, a commission-based fee model was compatible with the DOL Fiduciary Rule.”

As such, the Chairman noted that the package has four main components: 

  • the development of a new “best interest” standard of conduct for broker-dealers (the Regulation BI); 
  • a new requirement to issue a relationship summary to investors – the Form CRS Relationship Summary;
  • a reaffirmation of the fiduciary duty of conduct for investment advisers; and 
  • a confirmation of the “solely incidental” broker-dealer exclusion from the definition of investment advisor under the Advisers Act of 1940.

New Broker-Dealer Best Interest Standard

A little more than a year after proposing new fiduciary and best interest rules, the rules sure to draw the most attention – and the most criticism – is the new standard of conduct for broker-dealers. 

The final rule makes clear that this new standard of conduct applies to account recommendations, including a recommendation to rollover assets from a workplace retirement plan account to an IRA, and/or recommendations to take a retirement plan distribution. It also applies to implicit “recommendations to hold” that result from agreed-upon account monitoring. 

The rule also sets aside a reference in the SEC’s April 2018 proposed rule to a securities transaction in favor of a more general reference to retirement plans. And, when recommending a rollover for a participant in a retirement plan, the final Reg BI specifically requires a comparison of the IRA to the participant’s plan account.

To meet the new standard, broker-dealers must meet four obligations: disclosure, care, conflict of interest and compliance.

  • Account Recommendations. Material facts about the relationship and recommendations must be disclosed to retail investors. Before or at the time of the recommendation, a broker-dealer must disclose, in writing, material facts about the scope and terms of its relationship with the customer. This includes disclosure that the firm or representative is acting in a broker-dealer capacity; the material fees and costs the customer will incur; and the type and scope of the services to be provided, including any material limitations on the recommendations that could be made to the retail customer.
  • Care Obligation. Broker-dealers must exercise reasonable diligence, care and skill when making a recommendation to a retail investor. Here, the broker-dealer must understand potential risks, rewards and costs associated with the recommendation, and must then consider those risks, rewards, and costs in light of the customer’s investment profile and have a reasonable basis to believe the recommendation is in the customer’s best interest and does not place the broker-dealer’s interest ahead of the retail customer’s interest.
  • Conflict of Interest Obligation. Written policies and procedures must be established, maintained, and enforced that at a minimum discloses or eliminates conflicts of interest like sales quotas, bonuses and non-cash compensation based on the sale of specific securities. Clayton noted that, similar to the proposal, this provision establishes an “overarching obligation” to establish written policies and procedures that, among other things, are reasonably designed to mitigate or eliminate certain identified conflicts of interest.
  • Compliance Obligation. Broker-dealers must establish, maintain and enforce, policies and procedures reasonably designed to achieve compliance with this standard as a whole.

Form CRS Relationship Summary

Investment advisers and broker-dealers will now be required to deliver a relationship summary to retail investors at the beginning of their relationship. This will include summary information about services, fees and costs, conflicts of interest, legal standard of conduct, and whether the firm and its financial professionals have a disciplinary history. 

The summary will also have a standardized question-and-answer format to promote comparison by retail investors and it will permit the use of layered disclosure so that investors can more easily access additional information from the firm about these topics. 

Investment Adviser Interpretation

Here, the final interpretation reaffirms – and in some cases clarifies – certain aspects of the federal fiduciary duty that an investment adviser owes to its clients. 

Solely Incidental Interpretation

The interpretation confirms and clarifies the Commission’s interpretation of the “solely incidental” prong of the broker-dealer exclusion of the Advisers Act. Specifically, the final interpretation states that a broker-dealer’s advice as to the value and characteristics of securities or as to the advisability of transacting in securities falls within the “solely incidental” prong of this exclusion if the advice is provided in connection with and is reasonably related to the broker-dealer’s primary business of effecting securities transactions. 

Next Steps 

Regulation Best Interest and Form CRS will become effective 60 days after they are published in the Federal Register, but there will be a transition period until June 30, 2020, to give firms time to comply. The Commission’s interpretations under the Advisers Act will become effective upon publication in the Federal Register.

Commissioner Hester Peirce acknowledged that the compliance period is “an ambitious one,” and said that she would be open to requests for more time to comply – at least from those firms showing diligent compliance.

To assist firms with planning for compliance, the Commission is establishing a Standards of Conduct Implementation Committee comprised of representatives from various divisions within the SEC. The Commission will also embark on a broad consumer education campaign to bring attention to the new rules. 

Following are links to the text of the final Regulation Best Interest, Form CRS and Commission interpretations. Additional information, including instructions for Form CRS and Form ADV, can also be obtained on the SEC’s final rule web page. 

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All comments
Jim Phillips
2 months 1 week ago
The concept of Form CRS is fine. Anything that helps the consumer to make an informed decision is a step in the right direction. The SEC describes Form CRS as being, " to provide a brief relationship summary to retail investors." It is interesting to note that their accompanying description of the brief summary is 524 pages long! We're lucky to have excellent attorneys and consultants to help us sort through this, but I have to wonder if the guidance were more succinct if perhaps compliance would be more widespread...