Is Your Investment Adviser and Broker-Dealer Working In Your Best Interest?
Investors work with a financial adviser or stockbroker to manage their investments and to meet their own and their families’ financial goals.
Today, there are more than 2,700 broker-dealers registered with the Securities Exchange Commission (SEC). These broker-dealers provide services to retail investors, with nearly $4 trillion in total assets and almost 139 million customer accounts.
Additionally, there are more than 8,000 SEC-registered investment advisers that provide services to retail investors, with more than $41 trillion in assets under management and more than 40 million client accounts.
These investors feel their finances are in good hands, relying on broker-dealers and investment advisers for investment advice that they expect to be given in the investors’ best interest.
This isn’t always the case, though.
The Business Trial Group breaks down a recent regulatory development that aims to require broker-dealers to now put their clients’ interests first, but in reality may fall short of changing much.
FINANCIAL ADVISERS AND BROKERS
There is a distinction to be made between financial advisers and broker-dealers.
A broker, which is defined broadly by the SEC as “any person engaged in the business of effecting transactions in securities for the account of others,” is typically paid on a commission basis based on fees generated from the products they recommended.
Registered investment advisers, or financial advisers, typically use a fee-based structure, such as a percentage of assets under management that is charged on an annual basis.
Financial advisors are bound to a fiduciary standard under the Investment Advisers Act of 1940 that requires them to put their client’s interest ahead of their own. This standard is regulated by the SEC or state securities regulators.
Meanwhile, broker-dealers — until very recently — only had to fulfill a suitability obligation under the Securities Exchange Act of 1934 that required only that brokers must reasonably believe that any recommendations made are suitable for clients, in terms of their financial needs, objectives, and unique circumstances. There was no specific obligation under the Exchange Act that broker-dealers make recommendations that were in clients’ best interest.
A new rule under the Exchange Act called “Regulation Best Interest” aims to hold these brokers accountable to put customers’ interests first. However, this new rule’s effectiveness may be in question.
WHAT IS THE SEC’S ‘REG BI’ STANDARD?
On June 5, the SEC passed a new rule under the Exchange Act called “Regulation Best Interest” (or “Reg BI”).
The goal of Reg BI was to give investors similar care from brokers and advisers, where brokers would be subject to Reg BI and investment advisers would still be fiduciaries.
Under Reg BI, the broker-dealer standard of conduct is purportedly enhanced beyond existing suitability obligations. The rule establishes a new standard of conduct for broker-dealers when making a recommendation of any securities transaction or investment strategy involving securities to a retail customer.
This standard of conduct requires brokers to act in the best interest of their customers at the time a recommendation is made without placing the financial or other interest of the broker-dealer ahead of the interest of the customer. This includes recommendations of account types and rollovers or transfers of assets and also covers implicit hold recommendations resulting from agreed-upon account monitoring.
There are, however, key differences between Regulation Best Interest and the Advisers Act’s fiduciary standard that reflect the distinction between the services and relationships typically offered under the two business models.
For example, an investment adviser’s fiduciary duty generally includes a duty to provide ongoing advice and monitoring, while Regulation Best Interest does not impose such duty. Instead, it only requires that a broker-dealer act in the retail customer’s best interest at the time a recommendation is made.
WHAT DOES IT REALLY MEAN?
The new rule may be more form than substance.
First of all, the rule does not create a fiduciary standard of care across the board among financial advisors and broker-dealers.
The new rule includes many elements that are similar to the Department of Labor’s now-vacated Fiduciary Rule, including the enhancements to the broker-dealers’ standards of conduct. However, it does not create a uniform standard across brokers and advisers.
Rather than requiring a standard of care for anyone engaging in investment advice, broker-dealers can continue to adhere to only the “best interest” standard.
It’s also unclear if broker behavior will change much from the current suitability standard.
The new rule requires brokers to disclose and mitigate conflicts, but it is not entirely clear how mitigation will work. The rule also lacks enforcement and teeth to hold brokers to this new “best interest” standard.
For instance, Reg BI prohibits specific product sales competitions, because sales competitions with award trips, bonuses and other rewards tend to prioritize growth over customer care. However, the rule does not clearly prohibit an overall competition and bonus system for selling a certain type of product.
As a result, all a firm would have to do is restructure its sales competition program and continue the status quo.
WHAT HAPPENS NEXT?
Registered broker-dealers must begin complying with Regulation Best Interest by June 30, 2020. At that time, broker-dealers and investment advisers registered with the SEC will be required to prepare, deliver to retail investors, and file a relationship summary.
However, it’s yet to be known how exactly Reg BI will be enforced.
In addition, the DOL is unlikely to do anything more in the fiduciary arena anytime soon.
Members of the DOL have said that the Labor Department will align with the finalization of Reg BI to avoid the confusion different regulations can create.
If the DOL adopts a rule for brokers adhering to the SEC’s “best interest” rule, this could allow brokers to advise on 401(k)s, IRAs and other retirement accounts without taking on additional liability or a higher standard of care.
CONTINGENCY-FEE INVESTMENT LOSS ATTORNEYS
If you suffered investment losses due to possible adviser misconduct or securities regulations violations, the Business Trial Group’s securities litigation attorneys represent clients on a contingency-fee basis nationwide.
The Business Trial Group attorneys have helped investors recover millions of dollars in losses sustained by securities fraud.
With its contingency-fee model, the firm can provide clients the benefits of a large firm without the burden of hourly fees. This levels the playing field between investors and the powerful securities firms and ensures a fair trial or arbitration process.