New regulations from the SEC, under the tag "Regulation Best Interest", involve significant changes to the North American wealth management landscape. Do they achieve the goal of protecting investors or have they actually set the clock back and built problems for the future? This article takes a critical view.

Since June 30, the new Regulation Best Interest standard has been in force, imposing a set of new reporting requirements on the wealth management industry. The introduction of Regulation BI by the Securities and Exchange Commission has been controversial, to say the least. We have already gotten plenty of commentary from the sector about its effects. In some respects, the arguments echo the sort seen when the European Union rolled out its regulatory blockbuster, MiFID II, aka the second iteration of the Markets In Financial Instruments Directive. Such regulations are, their framers say, designed to protect investors, make wealth managers and other players more open about fees and costs, and reduce conflicts of interest. As readers know only too well, the detail of how these fine ambitions translate into reality is the hard part. (Senior wealth management industry figures criticized the SEC rule as being a “far cry from the existing fiduciary standard required of registered investment advisors”.)

Knut Rostad, president at Institute for the Fiduciary Standard, explores Regulation BI and offers a number of criticisms and observations. The editorial team at Family Wealth Report is pleased to share these views; the usual editorial disclaimers apply. Jump into the conversation and email the team if you want to reply or expand on this topic. Email tom.burroughes@wealthbriefing.com and jackie.bennion@clearviewpublishing.com

A sharply contested, decade-long bureaucratic battle culminated on June 30 when the SEC’s highly anticipated Regulation BI finally took effect.

Broker-dealers, led by SIFMA, the industry’s lobbying group, strongly favored the new rules. Indeed, Reg BI faithfully represents the principles SIFMA laid out for the SEC nine years ago.

Unfortunately, the new regulation is being hailed as “a giant step forward” for the wealth management business, as reflected in the recent Barron’s headline “An Improving Standard of Care.”

Reg BI takes the advisory business backward, not forward. 
Most critically, the new regulation implicitly abandons the principles of the Investment Advisors Act of 1940, which carefully differentiates the roles, functions and purposes of investment advisors and broker-dealers. 

Here are five myths about Regulation BI and Form CRS, the SEC’s uniform disclosure document:

-- Reg BI is an important “enhanced standard of conduct” over the suitability standard. 

The SEC says the new best interest standard mirrors the suitability standard. This includes the “inability to disclose away a broker-dealers’ suitability obligation" and a requirement to make recommendations that are “consistent with his customers’ best interest.”  

--  Reg BI requires that conflicts be mitigated.

Reg BI requires that firms “establish written policies and procedures reasonably designed to mitigate or eliminate” certain conflicts. Only conflicts that the BD firm deems “create an incentive” for the firm or broker to put their interests ahead of the customer require mitigation. How these incentives differ from other conflicts brokers face is unclear.

Conflicts that influence or prejudice a broker are, per se, just fine with the SEC and can be disclosed and do not require mitigation. Yet, the SEC implies that at some undefined point incentives change the broker’s status. 

For example, in March 2019 the SEC chair said “Disclosure is enough mitigation” in some cases, while in July 2019, he said disclosure alone “Is not enough.”

It depends on, “What would a reasonable investor expect?”

-- Reg BI requires that fees be disclosed.

The SEC requires that potential sources of commissions and other compensation be disclosed. Or, how broker-dealers and brokers are paid. Ameriprise uses 16 pages in its ADV to identify how its entities and brokers can be paid. Reg BI, however, does not require what clients pay or how firms are compensated. The SEC explains the discrepancy, saying that we “are not requiring personalized fee disclosures.”   

“Hiding” costs associated with working with a broker is not new. Many investors, as author John Wasik reminds us, know they don’t know what they pay. Is there another business service where an upfront estimate and a reasonable accounting at project or year’s end is routinely denied? Who would get their car fixed, kitchen renovated, or a will prepared, without knowing what they have to pay?

--  Form CRS helps investors screen advisors and brokers. 

Form CRS makes brokers and advisors and their conflicts appear the same. They are described as largely indistinguishable, as seen in the required language for a dual registrant:

“When we provide you with a recommendation as your broker-dealer, or act as your investment advisor, we have to act in your best interest and not put our interest ahead of yours. At the same time, the way we make money creates some conflicts with your interests. You should understand and ask us about these conflicts because they can affect the recommendations and investment advice we provide you.”

-- Reg BI is based on fiduciary principles. 

The new standards throw out the principles of the Investment Advisors Act of 1940, based on the different roles, functions and purposes of investment advisors and broker-dealers. Customers of brokers are in relationships of three with their broker and the firms that pay BDs to distribute products. Clients of advisors are, however, in relationships of two with an advisor the client pays to render advice. The Advisors Act of 1940 honors these differences and regulates advisors separately. 

In the end, Reg BI and Form CRS rules and guidance leave most retail investors with brokers who will “talk best interest” and act to sell. 

What’s the best strategy for investors? Think Harry Truman. Demand that any advisor or broker “Show you” and meet the Real Fiduciary practices.

About the author
Knut Rostad served as the regulatory and compliance officer at Rembert Pendleton Jackson, an RIA in Falls Church, Virginia, for ten years until early in 2015. He co-founded the non-profit Institute in 2011, which has sought to advance the fiduciary standard through research, education and advocacy. He has been a leading industry thought leader on all matters fiduciary, appearing regularly at industry conferences and seminars.

Rostad is also the editor of The Man in the Arena: Vanguard Founder John C Bogle and His Lifelong Battle to Serve Investors First (Wiley).