Posted by There was a time when the most heated, public debate about the word “advisor” was whether to spell it with an “e” or an “o.” As for the definition, that was always a bit broader and blurrier, as everyone from RIAs to broker-dealers used the word to describe the professionals who provided financial services to their clients – but there was a catch: only some had true fiduciary responsibility. While SEC-registered RIAs are required by government regulation to act only in a client’s best interest, FINRA-registered brokers act on that private industry group’s “reasonable grounds” basis. That is, while they should act in their client’s best interest, they aren’t bound by regulation to do so.
On June 30th, the SEC will bring that blurred definition of “advisor” into focus, when it begins enforcing Regulation Best Interest. While not being held to the same fiduciary standard as an RIA, broker-dealers are, as the regulation states, under a “general obligation” when making an investment recommendation to “act in the best interest of the retail customer at the time the recommendation is made, without placing your financial or other interest ahead of the retail customer’s interest.”1
Setting aside for a moment all of the regulatory requirements and implications, what this does, more than anything else, is draw a firm line in the sand demarcating the difference between advisors as advisors and broker-dealers as sellers. And you can read it in the SEC’s own words (yes, we’re quoting many of them – but it’s always better to approach this kind of a conversation from a “don’t take our word for it” perspective):
“Importantly, regardless of whether a retail investor chooses a broker-dealer or an investment adviser (or both), the retail investor will be entitled to a recommendation (from a broker-dealer) or advice (from an investment adviser) that is in the best interest of the retail investor and that does not place the interests of the firm or the financial professional ahead of the interests of the retail investor.” 2
“Advice” has been and will continue to be the end result of a holistic review and analysis of a client’s financial world and remains in the realm of the advisor – something quite different from recommending and selling a product. Now, though, sellers – broker-dealers – will have an obligation to ensure that what they sell is more closely aligned with their client’s best interest.
This obligation is broken down into four key components: disclosure, care, conflict of interest and compliance. Broker-dealers will have to provide complete information about, exercise due diligence in, and maintain documents to prove no conflicts of interest regarding and compliance with regulations surrounding each and every recommendation.
“Full disclosure” is truly at the heart of this regulation – and is also one of the sticking points for its proponents and opponents. But before we get to that, let’s take a look at how that disclosure will be achieved after June 30.
The Client Relationship Summary
Both broker-dealers and RIAs are facing new forms with which to provide full disclosure about every aspect of their relationship: for investment advisers, broker-dealers and dually-registered firms, Form CRS (Client Relationship Summary) is required, while Part 3 of Form ADV is required for RIAs. The information covered by these forms is truly “soup to nuts” – fees, service menu, how an investor can find more information – that also includes any disciplinary actions that have been taken against the broker-dealer or RIA, as a firm or individuals associated with the firm.
Who will be the beneficiary of these new disclosures? Any retail customer, defined by the SEC as, “a natural person, or the legal representative of such person, who receives a recommendation of any securities transaction or investment strategy involving securities from a broker-dealer; and uses the recommendation primarily for personal, family, or household purposes.”3
Is everybody happy? Not really…
But while retail customers may rejoice at a new level of protection (which, like all previous and future forms of protection only work if they actually read the document[s]) not everyone is satisfied.
Like all hot-button regulations (and there is no doubt that this more than qualifies), there has been debate on all political and investment professional fronts: some say it goes too far, others that it doesn’t go far enough and, still others who believe that it waters down the existing advisor fiduciary duty.
In a far-ranging speech given in Boston on July 8, 2019 – just a month after the regulation was passed – SEC Chairman Jay Clayton addressed concerns from all sides of those impacted. Included in this was what we wrote above: a finger pointed directly at retail investors putting the responsibility of “doing their homework” squarely on them before considering any advisor or investment.
In a nutshell, Chairman Clayton noted that:
- There is no legal or regulatory basis for the claim that Regulation Best Interest weakens the existing fiduciary duty that applies to investment advisors by not requiring advisors to avoid all conflicts – nor does it weaken the requirement that advisors “put clients first.”
- Claiming “best interest” is poorly defined and doesn’t require a broker to recommend the “best” security is refuted by the framers applying the same “principles-based” approach to “best interest” that is in an investment advisor’s fiduciary duty.
- Developing the regulation without requiring broker-dealers to monitor a customer’s account or impose an ongoing duty was done so to let investors choose whether or not they want ongoing monitoring and the associated costs.4
The speech is a worthwhile read in its entirety – you can find a link to it in the notes below.
Some observers have noted that interpretation leaves wiggle room. For instance, brokers at dual-registered firms may be able to exploit a loophole that allows them to continue to refer to themselves as advisers, since the client relationship is not exclusively through a broker-dealer. Some would argue this defeats the spirit of the rule. Indeed, XY Planning Network has filed a lawsuit against the SEC relating to this issue, and Michael Kitces has written a nice overview of the issue, for those who are curious to learn more.5 Additional clarification on this point may be forthcoming.
Ultimately, compromise is what happens when everyone walks away both happy and unhappy with the how a problem is resolved. In the case of Regulation Best Interest, it more clearly delineates the difference between broker-dealers and advisors to ensure that everyone, to use a modern parlance, “stays in their lane,” elevates the standard of behavior for broker-dealers and more firmly entrenches the advisor – the true, fiduciary advisor – in the role of a client’s trusted source for end-to-end financial guidance.
With that settled, we can now return to addressing the most nagging question facing the financial services industry: resolving how to spell advisor. Adviser?
1 Regulation Best Interest: A Small Entity Compliance Guide, U.S. Securities and Exchange Commission (2019), https://www.sec.gov/info/smallbus/secg/regulation-best-interest#Introduction.
2 Regulation Best Interest: The Broker-Dealer Standard of Conduct, RIN 3235-AM35, 17 CFR Part 240 (2019), https://www.govinfo.gov/content/pkg/FR-2019-07-12/html/2019-12164.htm.
3 Regulation Best Interest: A Small Entity Compliance Guide, U.S. Securities and Exchange Commission (2019), https://www.sec.gov/info/smallbus/secg/regulation-best-interest#Introduction.
4 Clayton, Jay, “Regelation Best Interest and the Investment Fiduciary Duty: Two Strong Standards that Protect and Provide Choice for Main Street Investors,” 2019, https://www.sec.gov/news/speech/clayton-regulation-best-interest-investment-adviser-fiduciary-duty.