The securities rules are changing and retail investors should benefit.
Earlier this year the SEC adopted a new set of rules designed to enhance investor protection while preserving investor product access and investor choice related to how investors get and pay for their advice and the advice givers with whom they work. This series of rules known as “Regulation Best Interest” imposes new standards of conduct on broker-dealers that substantially enhances their responsibilities beyond the current suitability obligations. While not totally there, these new rules move the securities industry closer to the fiduciary standard currently applied to registered investment advisor relationships. This new set of securities laws becomes effective on June 30, 2020.
Between now and next June, broker-dealers will be modifying compliance and written supervisory procedures, conducting training sessions, rewriting computer programs and systems. This law is a big change for the securities industry which will raise their supervisory and business standards. Some key points of this new legislation follow:
Under Regulation BI broker-dealers will be required to act in the best interest of their retail customers when making a recommendation of any securities transaction or investment strategy. In other words, the best interests of the customer need to come before those of the broker-dealer.
- DISCLOSURE OBLIGATION: Broker-Dealers must disclose material facts about the relationship and recommendations, including specific disclosures about the capacity in which the broker is acting, fees, the type and scope of services provided , conflicts limitations on services and products and whether the broker-dealer provides monitoring services.
- CARE OBLIGATION: A retail broker-dealer must exercise reasonable diligence, care and skill when making a recommendation to a retail customer. The broker-dealer must understand potential risks, rewards and costs associated with the recommendation. The broker-dealer must then consider these factors considering the retail customer’s investment profile and make a recommendation in the retail customer’s best interest considering those factors.
- CONFLICT OF INTEREST OBLIGATION: Broker-dealers must establish, maintain and enforce written policies and procedures reasonably designed to identify and at a minimum, disclose or eliminate conflicts of interests.
- Mitigate conflicts that create an incentive for the firm’s financial professionals to place the interests of the firm ahead of the retail customer’s interests.
- Prevent material limitations on offerings, such as a limited product menu or offering only proprietary products.
- Eliminate sales contests, sales quotas, bonuses and non-cash compensation that are based on the sale of specific securities or specific types of securities within a limited time.
- COMPLIANCE OBLIGATION: Broker-dealers must establish, maintain and enforce policies reasonably designed to achieve compliance with Regulation Best Interest as a whole.
Form CRS Relationship Summary
A new requirement from Reg BI is form CRS. This document is a relationship summary that investment advisors and broker-dealers will be required to deliver to their investors at the beginning of their relationship. It will summarize information about services, fees and costs, conflicts of interests, legal standard of conduct and whether the firm or its financial professionals have a disciplinary history. This form will be in a standardized question and answer format that should make it easy for retail investors to compare firms and services. It will also highlight various regulator sponsored investor education websites.
Terms not Defined
It is interesting that the term “Best Interest” and “Recommendation” are not defined by the regulators.