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SEC Adopts Regulation Best Interest, Raising Broker Standard of Care

The SEC adopted Regulation Best Interest for broker-dealers that make recommendations to retail clients. Regulation Best Interest, intended to enhance a broker’s standard of care beyond suitability, requires a broker-dealer to act in the retail customer’s best interest and to refrain from transactions that favor the interests of the broker over the customer. The new rule requires disclosure as well as policies and procedures to ensure that brokers identify and mitigate conflicts of interest. The SEC also adopted new Form CRS that requires both advisers and brokers to provide retail customers with standardized information about their relationship, including services, fees, conflicts, standard of conduct, and disciplinary history. The SEC also issued an interpretation that addresses an adviser’s fiduciary responsibilities. Part of this regulatory package includes a refining of the “solely incidental” exception to adviser registration for brokers. Firms have until June 30, 2020 to comply with Regulation Best Interest, although the new interpretations apply immediately upon publication.

Let’s rename this “The Compliance Officer Full Employment Act.” Compli-pros at broker-dealers will have to rework all of their Written Supervisory Procedures, revise client agreements, create disclosures, and eliminate all prohibited conflicts. Compliance offices at investment advisers must address the new Form CRS requirement and implement new client onboarding procedures while figuring out the changes required by the investment adviser fiduciary interpretation. And, we only have 12 months to get this all done.

The Friday List: 10 Examples of Brokers Behaving Badly

Today, we offer our “Friday List,” an occasional feature summarizing a topic significant to investment management professionals interested in regulatory issues.  Our Friday Lists are an expanded “Our Take” on a particular subject, offering our unique (and sometimes controversial) perspective on an industry topic.

The debate about the now-vacated DoL fiduciary rule and the recently proposed Regulation Best Interest continues.  We have argued that a uniform fiduciary standard should apply to both retail brokers and advisers.  Why?  We accept the position that retail consumers should not have to hire a lawyer to determine the advice standards to which his/her financial professional adheres.   More significant, however, is that brokers behave badly and need a higher standard.  An academic study that was first published in 2016 reported that 7% of broker-advisers have misconduct records, prior offenders are 5 times more likely to engage in misconduct, and 44% of brokers fired for misconduct are re-employed within a year.  The authors concluded: “We find that financial adviser misconduct is broader than a few heavily publicized scandals.”   They also argued that a more stringent standard would help the industry by improving the low reputation of financial professionals.  Our reporting of cases also shows endemic broker misconduct.  In today’s list, we highlight examples of brokers behaving badly, which should inform the debate on a uniform fiduciary standard.

 

10 Examples of Broker Behaving Badly

  1. Stealing from clientsA broker exploited a weakness in his firm’s control systems that allowed third party disbursements, enabling him to misappropriate $7 Million from clients.
  2. Churning.   A broker recommended an unsuitable in-and-out trading strategy that generated significant commissions.
  3. Misrepresenting disciplinary recordA broker’s website claimed he never had a complaint, even though several customers filed and settled complaints over the course of an 8-year period.
  4. Misusing client information. A broker shared nonpublic personal information (including holdings and cash balances) about clients with a person no longer affiliated with his firm.
  5. Revenue sharing.   A broker received undisclosed revenue sharing on mutual fund trades from the clearing broker.
  6. Undisclosed markups/markdownsAn interdealer failed to disclose markups and markdowns on securities traded for clients.
  7. Commission kickbacksA trading supervisor demanded commission kickbacks from junior traders to whom he assigned clients.
  8. Pump-and dumpA broker engaged in an ongoing penny stock pump-and-dump scheme.
  9. Bribing public officials.    A broker spent nearly $20,000 on hotels, meals and concert tickets to bribe a public plan official to secure brokerage business from a public plan.
  10. IPO kickbacks.   A broker and his client conspired in a kickback scheme whereby the customer would pay back 24% of his profits in exchange for preferred IPO and secondary offering allocations.

CCS’s Gillespie and Tyre Analyze Regulation Best Interest and Adviser Fiduciary Interpretation

The SEC recently proposed Regulation Best Interest, proposing a best interest conduct standard on retail brokers, and an expanded fiduciary interpretation applicable to investment advisers.  CCS’s Stacey Gillespie offers a summary of the expanded fiduciary interpretation, and Doug Tyre provides a description of the proposed Best Interest Standard.  Stacey analyzes how the SEC intends to interpret an adviser’s obligations of best execution, duty of care, duty of loyalty, and obligation to monitor.  Doug reviews how Regulation Best Interest would change a retail broker’s obligations to mitigate conflicts of interest, enhance disclosure, and exercise a heightened duty of care.  If you would like to discuss further, both Stacey and Doug are available to field your questions.

 

Regulation Best Interest 5-2-18

Fiduciary Rule Interpretation 5-2-18

 

SEC Proposes Broker Best Interest Standard

The SEC has voted to propose a best interest standard for broker-dealers giving advice to retail customers.  The proposed “Regulation Best Interest” requires a broker to act in the best interest of the retail customer at the time the recommendation is made, notwithstanding its own financial interests.  The broker must disclose its conflicts of interest and have a reasonable basis to believe the recommendation and the series of transactions are in the client’s best interest.  The proposal also requires that brokers and advisers deliver a new disclosure form describing the relationship and conflicts of interest.  A retail customer is defined as a person who uses the recommendation primarily for personal, family, or household purposes.  The Rule defers to existing broker-dealer regulation to define the term “recommendation.” The SEC also proposed a companion rule seeking to clarify an investment adviser’s fiduciary duty including the obligation to provide advice in the best interest of the client, a duty of best execution, a commitment to provide ongoing monitoring, and a duty of loyalty.  The SEC has provided a 90-day comment period.

OUR TAKE: Don’t change anything yet based on this proposal.  Expect much debate during the comment period and thereafter, as even one of the SEC Commissioners dissented.  Our view is that brokers should be subject to the same fiduciary standard as investment advisers.  We don’t understand why the SEC would take this half-measure and enhance the broker standard without making it the same as the adviser standard.  This confusion is bad for customers and for brokers.

 

CFP Board Proposes Fiduciary Standard

The CFP Board has proposed a broad fiduciary standard in its new Code of Ethics and Standards of Conduct.  The proposed fiduciary standard requires a CFP professional to exercise a duty of loyalty, which requires placing the client’s interests above those of the CFP or his/her firm, avoiding or fully disclosing conflicts of interest, and acting without regard to personal or firm financial interests.   The new Code requires disclosure of all conflicts of interest such that a client can provide informed consent.    Comments on the proposed Code are due on August 21.

OUR TAKE: Whether or not the DoL or the SEC moves ahead with a fiduciary standard, the CFP Code would apply a best interest standard to many of the high-end planners carrying the CFP designation.  The fiduciary genie appears to be out of the lamp.

 

The Friday List: 10 Things to Know about the DoL Fiduciary Rule

Today, we offer our “Friday List,” an occasional feature summarizing a topic significant to investment management professionals interested in regulatory issues.  Our Friday Lists are an expanded “Our Take” on a particular subject, offering our unique (and sometimes controversial) perspective on an industry topic.

Last Monday (May 22), the Department of Labor issued guidance on the implementation of the long-debated Fiduciary Rule.  Most significantly, the DoL did not further delay the basic concept that financial institutions and advisers must apply a best interest standard to advice for IRAs and other retirement accounts.  However, the DoL did back off of some of some of the compliance requirements for the rest of this year and plans to collect more information.  Below is a list of the 10 things you need to know right now about the DoL Fiduciary Rule.

 

10 Things to Know about the DoL Fiduciary Rule

 

  1. Applies to IRAs: The DoL Fiduciary Rule applies to investment advice concerning IRAs, ERISA plans, and plans covered by Section 4975 of the Tax Code.
  2. Best Interest standard starts June 9: Beginning June 9, financial institutions and advisers to covered plans must provide advice in the retirement investor’s “best interest,” which includes a duty of prudence and loyalty.
  3. BIC exemption compliance starts January 1: The extensive compliance requirements of the Best Interest Contract (BIC) exemption, which would apply to non-level fee products, are not required until January 1, 2018.
  4. DoL expects changes by January 1: During the Transition Period (June 9-January 1), the DoL will collect additional information from the industry to determine how compliance practices such as the use of mutual fund “clean shares” should re-shape the Rule.
  5. Proprietary products with commissions permitted: During the Transition Period, firms can recommend proprietary products with commissions so long as they satisfy the best interest standard.
  6. Need policies and procedures: The DoL expects firms to adopt policies and procedures necessary to ensure compliance with the best interest standard.
  7. Robo-advisers can rely on BIC exemption: Robo advisers may rely on the BIC Exemption during the Transition Period to ensure compliance with the Rule.
  8. Investment advice narrowly defined: Investment advice, for purposes of the Rule, does not include plan information or general financial, investment and retirement information.
  9. Can rely on written representations from intermediaries: The Rule does not apply if an independent fiduciary provides written representations (including negative consent) that the fiduciary is a bank, insurance company, BD, RIA, or independent fiduciary managing at least $50 Million.
  10. DoL will focus on compliance over enforcement: The DoL says it will prioritize compliance over enforcement during the Transition Period so long as firms work diligently and in good faith to comply with the Rule.