Thoughts on the Advent of SEC Regulation Best Interest

On the advent of SEC Regulation Best Interest (Reg BI), brokers are pressing forward with systemic changes to the way they conduct business. The new standard of care regulation for broker-dealers (BDs) went into effect on June 30, 2020. Here is a recap of selected elements of the regulation and what Aite Group  has been hearing from technology providers, broker-dealers, and industry advocates:

• Brokers have implemented Form CRS but have questions on delivery and tracking. Form CRS (also known as a client relationship summary) was meant to be a conduit for broker-client disclosure and enhanced client communication. The form has greater specificity than the broader best interest regulation and mandates client disclosures to increase business model transparency. For registered investment advisors (RIAs), it is a new section of Form ADV. For BDs it is a new disclosure. We are aware of questions from BDs around tracking and delivery, for example, could a posting on the website be enough to fulfill the regulation? We think not. Key to successful implementation of Form CRS is targeted client delivery and archival tracking. If Form CRS distribution is not memorialized and tracked by client at a given disclosure point, it did not happen as far as the SEC is concerned.
• A legal challenge to the regulation has failed. On Friday, June 26, 2020, the U.S. 2nd Circuit Court of Appeals ruled that the SEC acted properly under the Dodd-Frank Act in creating Reg BI . The plaintiffs will now focus on drawing attention to fiduciary regulation at the state level. Massachusetts became the first state to issue a new rule, “The Massachusetts Fiduciary Rule,” which went into effect on March 6, 2020, with an enforcement grace period extending until September 1, 2020. The new rule is meant to enforce a higher standard of fiduciary conduct than what was perceived to be implemented by with Reg BI. Other states may follow.
• The Department of Labor (DOL) is back in the conversation. On Monday, June 29, the DOL proposed a new rule that would allow investment fiduciaries working with retirement plans to expand the ways they can be compensated. This would include payments such as commissions, 12b-1 fees, sales loads, and revenue sharing payments that would otherwise violate prohibited transaction rules. At first glance, this seems contrary to client best interest. (We expect to hear more on that!) However, the DOL’s intention is to harmonize its regulation with the SEC. That said, we expect detractors to highlight and position the DOL language as an effort to lower an existing standard to accommodate Reg BI.
• Many brokers are still trying to understand the tactical changes needed to comply with Reg BI. Reg BI is built on a client duty of care, which covers client best interest in the context of four pillars: disclosure, care, conflicts of interest, and compliance. Brokers clearly need to understand risk, reward, and cost associated with client transactions and recommendations. Representatives and advisors should have a view that an investment transaction is in the reasonable best interest of the client, i.e., it fits the client investment profile, does not put BD interest ahead of client interest, and is not excessive in cost. To do that, the cost of the product must be examined, and the broker  should reasonably consider available investment alternatives. Every part of the advisor’s workflow should be documented, as disputes often occur years after the fact. We believe that many incumbents already do this; however, Reg BI will further change behaviors within a firm. Voluntary activity will become compulsory and need to be memorialized. With the added workflow encumbrance of these operating changes, technology will be adopted for scale. 
• The regulation puts additional focus on BD and advisor technology to scale business models. The confluence of events, including regulatory pressure, social distancing, compressing economics, market volatility, unemployment, and generally heightened anxiety make this a difficult environment to conduct financial services without good technology solutions. Digital client engagement and tech-driven integrated platform workflows are key. At the very least, we are seeing financial services providers coming to an enlightened view of the benefits of a good technology stack. BD and RIA technology providers see these environmental variables as enhancing their existing value propositions. We have spoken to several companies who are actively targeting or exploring solutions for Reg BI process compliance. These providers include Broadridge, HiddenLevers, InterGen DATA, InvestorCOM, NICE Actimize, and Riskalyze, among others.

Aite Group expects compliance and best practices for Reg BI to continue to play out for BDs over the next 12 months. Industry incumbents and stakeholders are taking their obligations under Reg BI seriously. A clear setback for greater understanding of the regulation was the inability for many BD reps to attend industry conferences that were scheduled to have training sessions and networking opportunities. That said, no institution wants to become the SEC poster child for fines and noncompliance. A failure on Reg BI will likely send the message that a wirehouse is not doing the right thing for its clients. In financial services, for an industry built on trust, nonperformance on Reg BI would be a potential public relations problem impacting an institution’s brand and reputation.