New Standards Seek to Maintain Flexibility But Leave Open Questions About Scope and Enforcement
On June 5, 2019, the Securities and Exchange Commission ("SEC") finalized Regulation Best Interest ("Reg BI" or the "Final Rule") under the Securities Exchange Act of 1934 ("Exchange Act") to establish a new "best interest" standard of conduct for broker-dealers when making a recommendation of any transaction or investment strategy involving securities to a retail customer.
The SEC also finalized its interpretation of the fiduciary duty applicable to investment advisers (the "Guidance") under the Investment Advisers Act of 1940 ("Advisers Act") and a disclosure form for investment advisers and broker-dealers to provide to retail investors ("Form CRS"). Finally, the SEC issued an interpretation on the scope of the "solely incidental" prong of the broker-dealer exclusion from the Advisers Act.
In finalizing Reg BI and the Guidance, the SEC has more closely aligned the standards of conduct applicable to broker-dealers and investment advisers while noting that it recognizes the fundamental differences between the services each provide. It also stressed a goal of maintain investors' ability to choose between the two.
Reg BI and Form CRS have a June 30, 2020 compliance date; the interpretations are effective upon publication in the Federal Register.
- Regulation Best Interest: The Final Rule largely maintained the obligations initially proposed, establishing a new standard of conduct for broker-dealers when recommending any securities transaction or investment strategy to a retail customer that requires a broker-dealer and its associated persons to (1) act in the retail customer's best interest and (2) not place their own interests ahead of the customer's interests ("General Obligation").
- While the Final Rule significantly overlaps with existing Financial Industry Regulatory Authority ("FINRA") suitability rules and related guidance, it includes specific disclosures and only requires mitigation or elimination of certain conflicts of interest.
- The Final Rule did not fully harmonize the standard of conduct applicable to broker-dealers and investment advisers, reflecting the SEC's goal of preserving retail investor access to different types of investor services and products and its acknowledgment of the differences between the two business models.
- Under the Final Rule, disclosure of firm-level conflicts, rather than mitigation as was proposed, is permitted, but mitigation continues to be required for conflicts of interest of a broker-dealer's associated persons.
- The SEC now has an independent basis to examine and enforce sales practice violations outside of the fraud context or referral to FINRA.
- Guidance: The Guidance summarizes the Commission's view on the current state of the law on investment advisers' duties to clients and prospective clients, with a few notable changes to the April 2018 proposal (the "Proposed Guidance").
- The Guidance distinguishes between institutional and retail clients in permitting advisers and clients to define the scope of the fiduciary relationship; however, the SEC did not provide additional guidance on how to make that distinction.
- The Guidance, in contrast to the proposal, retains the traditional facts-and-circumstances analysis for determining whether conflicts of interest can be cured through disclosure to institutional clients. However, disclosure may not be sufficient for retail clients in the case of very complex conflicts, in which case the Guidance would require mitigation or elimination.
- The Guidance does not impose additional substantive requirements for investment advisers that would mirror existing requirements for broker-dealers, specifically: (1) federal licensing and continuing education, (2) provision of account statements to clients, and (3) financial responsibility. The SEC is still evaluating the comments received on these proposed requirements, and said it may adopt one or more of these requirements in the future.
This Memorandum provides an overview of Reg BI and the Guidance, discusses our key takeaways, reflects on changes from the Reg BI proposal (the "Proposed Rule") and Proposed Guidance discussed in our prior Alert Memorandum, and describes implications for enforcement.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.