The Securities and Exchange Commission held an open meeting on April 18, 2018, during which the Commissioners voted 4 to 1 to release a package of rules, forms and interpretations for public comment designed to "enhance the quality and transparency of investors' relationships with investment advisers and broker-dealers" and to introduce a new disclosure form for use with retail customers.
Divided into three primary parts, the rule and guidance package would, among other things:
- establish a best interest standard for broker-dealers
- create a mandatory disclosure form summarizing brokers' and investment advisers' relationships with their clients and
- offer a new official interpretation affirming and clarifying the standard of conduct for investment advisers.
The proposals would also restrict brokers from using the titles "advisor" or "afdviser" in certain contexts and/or communications.
Best interest standard
The proposal would require a broker-dealer to act in the best interest of its retail customers when making a recommendation of any transaction or investment strategy involving securities, without putting its own interests ahead of the customer. The broker-dealer's compliance obligations under this new standard would be judged by three criteria – disclosure, care and conflicts of interest. As proposed:
- Broker-dealers must disclose key facts about the customer relationship, including conflicts of interest. Importantly, and unlike the Department of Labor's fiduciary rule, such conflicts of interest are not banned outright.
- Broker-dealers must exercise reasonable diligence, care, skill and prudence to (i) understand the product; (ii) have a reasonable basis to believe it's in the customer's best interest; and (iii) have a reasonable basis to believe that a series of transactions is in the customer's best interest.
- Broker-dealers must establish, maintain and enforce policies and procedures reasonably designed to identify, and, at a minimum, disclose and mitigate material conflicts of interest arising from financial incentives. Other material conflicts must also be disclosed.
The proposal would require investment advisers and broker-dealers, and certain of their investment professionals, to provide a standardized disclosure document – a client relationship summary (Form CRS) – that would address the nature of the customer relationship with them. The four-page form would provide a summary of the relationship with retail customers, as well as supplement other more detailed disclosures. It would highlight key differences in the principal types of services offered – eg, advisory versus brokerage – legal standards of conduct that apply, fees a customer may have to pay, and certain conflicts of interest.
Restriction on the use of "adviser" or "advisor"
Under the proposal, broker-dealers and financial professionals may be restricted from using the terms "adviser" or "advisor" as part of their title with retail investors. Additionally, in certain communications with retail investors, investment advisers and broker-dealers would be required to disclose their registration status with the SEC.
Interpretation of an investment adviser's fiduciary duty
The proposal includes new interpretative guidance that is intended to reaffirm and clarify the SEC's views as to certain aspects of the fiduciary duty that investment advisers owe their clients.
All of the SEC Commissioners stated that the proposal needs more work. Commissioner Kara M. Stein opposed the proposal as failing to provide enough protection and not going far enough in policing broker-dealers, maintaining that it effectively maintains the status quo. Commissioners Robert J. Jackson, Jr. and Hester M. Peirce said they were merely supporting issuing the proposal for public comment, withholding support for the proposal itself. In that regard, Commissioner Jackson said he generally supported the DOL's rulemaking effort and was reluctantly voting to put the proposal out for public comment, while Commissioner Pierce said that she had concerns about the clarity of the standards proposed; she said that she disagreed, however, with those who claimed that "the emperor had no clothes." Based on the initial reaction of the Commissioners, it is unclear how the Commissioners might ultimately vote on any final rules or guidance.
The proposal is open for comment during the 90-day period following publication in the Federal Register. If enacted, the rule could replace the Department of Labor's fiduciary rule. That rule was vacated by the Fifth Circuit Court of Appeals last month and remains under review, as directed by President Trump.
In general, the proposal appears to seek to heighten the duties applicable to broker-dealers, but does little to impact the current rules applicable to investment advisers other than the potential requirement to deliver the Form CRS to retail clients.
We are actively reviewing the SEC's nearly 900-page proposal and expect to provide commentary on the proposal during the comment period.