Stradley Ronon Reviews SEC Regulation Best Interest

Regulation Best Interest lays out the core loyalty and disclosure duties of advisers and broker/dealers—and how these can be satisfied.

Stradley Ronon on Thursday presented a detailed webinar exploring the Securities and Exchange Commission (SEC)’s Regulation Best Interest proposal, including analysis of the key themes to emerge in industry comment letters.

The webinar featured a diverse panel of regulatory experts, including Sarah Bessin, associate general counsel with the Investment Company Institute; David Grim, partner with Stradley Ronon; Helen Rizos, senior vice president and deputy general counsel for Fidelity Investments; and Larry Stadulis, co-chair of the fiduciary governance team at Stradley Ronon.

The panel agreed that the ongoing SEC activity on its proposed Regulation Best Interest should be a core area of focus for registered investment advisers (RIAs) and broker/dealers (B/Ds). While they spoke about the important influence of the Department of Labor (DOL)’s fiduciary rule saga on the SEC’s own regulatory activities, they explained how the roots Regulation Best Interest actually stretch as far back as 1995.

That year, Daniel Tully, then chairman and CEO of Merrill Lynch & Co., led an SEC-assembled committee in the publication of a report on advisory industry compensation practices. The “Tully Report,” now more than two decades old, voiced many of the same conclusions and concerns that current SEC chair Jay Clayton points to as the primary drivers behind Regulation Best Interest.

As the panel discussed, it was already known in the 1980s and 90s that retail investors, broadly speaking, can be easily confused about the differences between “investment advisers” and “broker/dealers.” The confusion is by all appearances just as prevalent, if not more significant, today.

For this reason, SEC Regulation Best Interest seeks to more clearly delineate the different standards and obligations of advisers and B/Ds. According to the panel, the B/D standard at this stage is not a fiduciary one. The adviser standard as restated in Regulation Best Interest is closer to the fiduciary approach taken by the DOL, but it has key differences that are inherent to the SEC’s own strengths and limitations as a securities-focused regulator.

According to the panel, there are some key concepts that will serve well as a jumping off point for coming into compliance with all the nuances of Regulation Best Interest as it is proposed—and with the various interrelated regulatory projects the SEC is working on alongside its best interest rule, such as the Customer Relationship Summary Form.

In no particular order, the panel emphasized the following concepts: Avoid compensation thresholds that disproportionately increase compensation through incremental sales increases; minimize compensation incentives for employees to favor one type of product over another, especially when it comes to proprietary or preferred provider products; consider establishing differential compensation criteria based on more neutral factors, such as the time and complexity of the work involved; and eliminate compensation incentives within comparable product lines.

The panel next offered a summary of the comment letters that have been submitted by industry stakeholders on Regulation Best Interest. Generally speaking there is broad support for the SEC to take the lead on a best interest standard for broker/dealers that will create more consistency across retirement and other retail accounts. Some comments urged SEC to coordinate closely with DOL, suggesting DOL should issue exemptions for financial professionals subject to SEC standards of conduct. Many spoke about the importance of getting positive affirmation that SEC standards of conduct would preempt inconsistent state law standards.

Some comment letters said the SEC is going too far and instead proposed that disclosure and client consent can be an effective means of satisfying broker/dealers’ loyalty obligations. They argued broker/dealers or investment advisers should not be precluded from using disclosure to limit the scope of their advice to a defined universe of products. They also argued it is not necessary to distinguish between conflicts of interest based on financial incentives and all other conflicts of interest.

The panel discussion concluded with a breakdown of the minimal, moderate and significant anticipated impacts of Regulation Best Interest as it is currently formulated. Minimal impact areas include the manner in which investment companies are regulated under the 1940 Act; the manner in which investment companies are managed and operated under the 1940 Act; board oversight of investment companies; and prospectus and shareholder communication disclosures.

Moderate impact areas, the panel said, include scheduled sales charge variations; use of multiple share classes; distribution arrangements under Rule 12b-1; and clean shares.

Major impact areas, according to the panel, will be individual retirement account (IRA) rollovers; non-cash compensation in connection with sales contests and promotions; compensation that incents the sale of one type of product over another, such as proprietary or preferred provider funds; increased emphasis on sales materials that do not include an actual recommendation; financial incentive conflicts arising from the receipt of revenue sharing or other payments from third parties; integrated fund product lineups specifically engineered to minimize financial incentive conflicts; the recommendation of complex investment company products to unsophisticated retail customers; and continued migration from B/D to adviser models.