On June 5, 2019, the SEC adopted a package of rules and interpretations (the Adopted Rules) to clarify and further articulate the relationship between retail investors and their broker-dealers or investment advisers. Specifically, the Adopted Rules include (i) the new Regulation Best Interest, which requires broker-dealers to act in the best interest of a retail customer when making investment recommendations (i.e., recommendations relating to a securities transaction or investment strategy); (ii) the new Form CRS Relationship Summary, which explains to investors the types of services being offered by a broker-dealer or investment adviser (and alternate services that could be provided) and discloses the investment adviser’s or broker-dealer’s applicable fees, conflicts of interest and disciplinary history; (iii) guidance restating and clarifying the SEC’s view on the fiduciary duty owed by investment advisers to clients under Section 206 of the Investment Advisers Act of 1940 (the Advisers Act) (the Investment Adviser Interpretation); and (iv) guidance clarifying the SEC view on the “solely incidental” prong of the broker-dealer exclusion under the Advisers Act (the Solely Incidental Interpretation). The SEC first proposed Regulation Best Interest in April 2018 against a backdrop of uncertainty regarding the Department of Labor’s 2016 “Fiduciary Rule,” which was vacated by the Fifth Circuit. The SEC voted 3-1 to approve the Adopted Rules, with Commissioner Robert Jackson, the sole Democratic commissioner, opposed. Rick Fleming, the SEC’s Investor Advocate, was also critical of various aspects of the Adopted Rules, including Form CRS and aspects of the Investment Adviser and Solely Incidental Interpretations, although he recognized that the adoption was, overall, a step forward. Key components of the Adopted Rules are summarized below.
Regulation Best Interest
Under Regulation Best Interest, when making investment recommendations to retail clients, a broker-dealer must act in the retail client’s “best interest” and cannot place its own interest ahead of such client’s interests. This includes recommendations of account types such as rollovers or transfers of assets in workplace retirement plan accounts to IRAs as well as recommendations to take plan distributions, and it also covers implicit hold recommendations resulting from agreed-upon account monitoring. Regulation Best Interest includes the following key components:
- Disclosure Obligation: Broker-dealers must disclose to the client the material facts relevant to the relationship and recommendations, including material conflicts of interest.
- Care Obligation: Broker-dealers must exercise reasonable diligence, care and skill in making a recommendation or series of recommendations to a client, including that the client understands potential risks, rewards and costs associated with the recommendation.
- 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 material conflicts of interest. Specifically, the policies and procedures must:
- Mitigate conflicts that create an incentive for a firm’s financial professional to place its interests or the interest of the firm ahead of the client’s interest.
- Prevent material limitations on offerings (e.g., a limited product menu or offering only proprietary products) from causing the firm or its financial professional to place its interest ahead of the client’s interest.
- Eliminate sales contests and quotas, bonuses and non-cash compensation that are based on the sale of specific securities or types of securities within a limited time period.
- Compliance Obligation: Broker-dealers must establish, maintain, and enforce written policies and procedures reasonably designed to achieve compliance with Regulation Best Interest as a whole.
The compliance date for Regulation Best Interest is June 30, 2020.
Form CRS Relationship Summary
Form CRS requires broker-dealers and investment advisers to deliver a relationship summary to retail investors at the start of their relationship. The relationship summary will include information regarding (i) the types of client and customer relationships and services the firm offers; (ii) the fees, costs, conflicts of interest, and required standard of conduct associated with those relationships and services; (iii) whether the firm and its financial professionals currently have a reportable legal or disciplinary history; and (iv) how to obtain additional information about the firm. The compliance date for Form CRS is June 30, 2020.
Investment Adviser Interpretation
Under Section 206 of the Advisers Act, an investment adviser owes its client a fiduciary duty, which is comprised of a duty of care and a duty of loyalty. The Investment Adviser Interpretation reaffirms and clarifies certain aspects of such fiduciary duty, noting that the duty is broad and principles-based and applies to the entire adviser-client relationship. Among other items, the Investment Adviser Interpretation includes examples of the application of the fiduciary duty to institutional investors and clarifies the SEC’s interpretation of what constitutes full and fair disclosure and informed consent.
Solely Incidental Interpretation
The Advisers Act excludes from the definition of “investment adviser” any broker-dealer that provides advisory services when such services are “solely incidental” to the conduct of the broker-dealer’s business and when such incidental advisory services are provided for no special compensation. The Solely Incidental Interpretation clarifies that a broker-dealer’s advice as to the value and characteristics of securities or to the advisability of transacting in securities falls within the “solely incidental” exclusion if the advice is provided in connection with and is reasonably related to the broker-dealer’s primary business of effecting securities transactions.
For additional information on the Adopted Rules, please visit here