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SEC Adopts New Standards for Broker-Dealers and Investment Advisers


June 20, 2019
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The Securities and Exchange Commission Recently Adopted New Standards for Broker-Dealers and Investment Advisers

The Securities and Exchange Commission (SEC) recently adopted new standards for broker-dealers and investment advisers. The centerpiece of the new rule is Regulation Best Interest, which enhances the quality and transparency of investors’ relationships with investment advisers (IAs) and broker-dealers (BDs) while preserving access to various types of advice relationships and investment products. The SEC adopted new Form CRS Relationship Summary, and two separate interpretations under the Investment Advisers Act of 1940.

SEC Adopts New Standards for Broker-Dealers and Investment Advisers

Rationale Behind SEC’s New Regulations

The SEC adopted this package of new standards to enhance and clarify conduct standards applicable to BDs and IAs.  Investors will better understand and compare the services offered and make an informed choice of the relationship best suited to their needs and circumstances.  The new standards will foster greater consistency in the level of protections provided by each regime, particularly at the point in time that a recommendation is made to an investor.

“The rules and interpretations we are adopting today address issues that the Commission has been actively considering for nearly two decades,” said SEC Chairman Jay Clayton.  “Our staff, working collaboratively across all of our Divisions and many of our Offices, has leveraged its decades of experience and expertise in considering these issues.  I believe that the exceptional work of the SEC staff, including their careful evaluation of the feedback we received, will benefit retail investors and our markets for years to come.  This rulemaking package will bring the legal requirements and mandated disclosures for broker-dealers and investment advisers in line with reasonable investor expectations, while simultaneously preserving retail investors’ access to a range of products and services at a reasonable cost.”

Regulation Best Interest

Under Regulation Best Interest, a BD making a recommendation of a securities transaction, or an investment strategy involving securities to a retail customer, would have a duty to act in the best interest of the retail customer at the time the recommendation is made, without putting the financial or other interests of the broker-dealer ahead of the retail customer. A BD would discharge this duty by complying with four specific obligations:

  • Disclosure: mandatory disclosure of material facts about the relationship and recommendation, 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 firm provides monitoring services for the recommended investment. 
  • Care: must exercise reasonable diligence, care, and skill when making a recommendation to a retail customer.  The BD must understand the potential risks, rewards, and costs associated with the recommendation.  The BD must then consider these factors in light of the retail customer’s investment profile and make a recommendation that is in the retail customer’s best interest.  The final regulation, which is an enhancement from the proposal, explicitly requires the BD to consider the costs of the recommendation.
  • Conflict of Interest: must establish, maintain, and enforce written policies and procedures reasonably designed to identify, and at a minimum disclose or eliminate, conflicts of interest.  This obligation, which is an enhancement from the proposal, specifically requires policies and procedures to:
    • Mitigate conflicts that create an incentive for the firm’s financial professionals to place their interest or the interests of the firm ahead of the retail customer’s interest;
    • Prevent material limitations on offerings, such as a limited product menu or offering only proprietary products, from causing the firm or its financial professionals to place his or her interest or the interests of the firm ahead of the retail customer’s interest; and
    • 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 period of time.
  • Compliance: In an enhancement from the proposal, BDs must establish, maintain and enforce policies and procedures reasonably designed to achieve compliance with Regulation Best Interest as a whole.

Form CRS

Investment advisers and broker-dealers will be required to provide retail investors a with form summarizing their relationship. This standardized, short-form, known as Form CRS (Customer/Client Relationship Summary), informs retail investors about: (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 reportable legal or disciplinary history; and (iv) how to obtain additional information about the firm.

Form CRS will reference a page on the SEC’s investor education website, Investor.gov, which offers educational information to investors about investment advisers, broker-dealers, and individual financial professionals and other materials. Retail investors will receive a relationship summary at the beginning of a relationship with a firm, communications of updated information following a material change to the relationship summary, and an updated relationship summary upon certain events. Notably, Form CRS is subject to SEC filing and recordkeeping requirements.

Standard of Conduct for Investment Advisers:  Two Interpretations:

The SEC also published two separate interpretations under the Investment Advisers Act of 1940. The first sets forth the agency’s interpretation of the “federal fiduciary standard” applicable to investment advisers under Section 206(1) and (2) of the Advisers Act, and reaffirms that registered investment advisers owe a fiduciary duty to their clients, including duties of loyalty and care. 

The second interpretation involves the “solely incidental” prong of the BD exclusion under the Advisers Act. It excludes from the definition of investment adviser—and thus from the application of the Advisers Act—a broker or dealer whose performance of advisory services is solely incidental to the conduct of his/her business as a broker or dealer and who receives no special compensation for those services. 

The SEC’s new interpretation expressly states that a broker-dealer’s advice as to the value and characteristics of securities, or as to the advisability of transacting in securities, falls within the “solely incidental” prong of this exclusion if the advice is provided in connection with and is reasonably related to the broker-dealer’s primary business of effecting securities transactions.

What’s Next?  Publication, June 30, 2020 Effective Date, SEC Standards of Conduct Implementation Committee.

Regulation Best Interest, Form CRS and the SEC’s new interpretations will become effective 60 days after they are published in the Federal Register.

A one-year implementation period is provided.  By June 30, 2020, registered BDs must begin complying with Regulation Best Interest and BDs and IAs registered with the SEC will be required to prepare, deliver to retail investors, and file Form CRS.

The SEC is also establishing an inter-Divisional Standards of Conduct Implementation Committee to address implementation concerns.  Given the operational changes necessitated by the new rules, we encourage BDs and IAs to contact the author or one of our experienced regulatory attorneys with any questions or concerns. 

If you have questions, please contact us

If you have any questions or if you would like to discuss the matter further, please contact me, Paul Lieberman, or the Scarinci Hollenbeck attorney with whom you work, at 201-806-3364.