Regulation Best Interest Arrives

Art by Julie Benbassat

As the name suggests, the Securities and Exchange Commission (SEC)’s Regulation Best Interest (Reg BI) establishes a “best interest” standard of conduct. This will be used by registered investment advisers (RIAs), broker/dealers (B/Ds), and associated personnel when they make a recommendation to a retail customer—i.e., an individual person—of any securities transaction or investment strategy involving securities, including recommendations of types of accounts.

Tied into the broad rulemaking package is a related clarification and restatement of the SEC’s understanding of the fiduciary duty applying to investment advisers under the Investment Advisers Act of 1940. Both aspects of Reg BI take full regulatory effect as of that end of June date.

Matt Radgowski, head of adviser solutions for Morningstar, says he is often called on to discuss the ways in which Reg BI goes further than the current suitability standard enforced by the Financial Industry Regulatory Authority (FINRA). He says most advisers recognize that Reg BI imposes significant new care obligations “above suitability” that include evaluating costs as well as reasonable alternative investments for investors—and that they will need to carefully address more complex use cases, such as 401(k) rollovers into individual retirement accounts (IRAs).

Ultimately, Radgowski says, he expects Reg BI “will require brokers to rethink the role of the adviser,” meaning the Reg BI framework may discourage commission-based business. As one might expect, some common practical areas are emerging where firms face challenges with compliance assessments, he says.

“For example, it’s a difficult balancing act to decide how much discretion and flexibility home offices will give to their outside advisers and representatives,” he says. “How much control will the home office maintain in terms of product choices, client service models, fee structures, etc.? Who will define what best interest means for the firm? Creating the customer relationship summary [CRS] form was just the first step. Actually, changing workflows and systems is a lot harder.”

Some states have already moved to incorporate the federal rulemaking into their securities law. One is Iowa, which in mid-May filed an “adopted regulation” via its insurance division to require annuity agents to act in the best interest of their customers. Importantly, the Iowa regulation now includes a caveat to the effect that regulated entities that meet the standards prescribed by Reg BI will be assumed to be complying with Iowa’s regulation. More progressive states have foregone including such an exception in their insurance and brokerage conflict of interest laws. 

Advice for Stragglers

Morningstar recently surveyed nearly 100 broker/dealers (B/Ds) and found almost one-third either were unsure if their firm had or knew it had not taken “any proactive steps” to ensure its products complied with Regulation Best Interest. For B/Ds that have been dragging their feet, the Financial Industry Regulatory Authority suggests tackling the following questions. Any “no” answers should be addressed by June 30.