Securities Regulation Daily Clayton defends Reg BI, Form CRS, and related interpretations
Tuesday, July 9, 2019

Clayton defends Reg BI, Form CRS, and related interpretations

By Amy Leisinger, J.D.

The chairman responded to criticisms of the new standard for broker-dealers when making recommendations to retail customers and noted that the changes will provide investor protection while preserving investor choice.

In recent remarks, SEC Chairman Jay Clayton provided an overview of the Regulation Best Interest rulemaking package and responded to commentary on issues surrounding the changes. According to the chairman, much of the criticism is "misleading, misguided, and unfortunately, in some cases, is simply policy preferences disguised as legal critiques." The rule changes and interpretations will enhance the quality and transparency of retail investors’ relationships with broker-dealers and investment advisers and better align requirements and mandated disclosures with reasonable investor expectations, he stated.

Response to criticisms. Clayton noted that several commenters advocated the end of a distinction between the broker-dealer and investment adviser standards, generally favoring the investment adviser model. However, the chairman explained, the rulemakings and interpretations are designed to increase investor protection while preserving access and choice for retail investors. For some investors, the broker-dealer model better fits their goals: for long-term investments, it may be more cost-effective to pay a one-time commission to a broker-dealer as opposed to an advisory fee investment, Clayton opined. "[A] one-size fits all approach could reduce the availability and increase the cost of advice and services, particularly for those with relatively smaller accounts," he stated.

Other commenters argued that Regulation BI will not do enough to protect retail investors, but, according to Clayton, the changes enhance the standard of conduct for broker-dealers by establishing a standard for transaction-based advice drawing on principles underlying the investment adviser fiduciary duty. Regardless of whether a retail investor chooses a broker-dealer or an investment adviser, the recommendation or advice must be in the investor’s best interest and cannot place the business ahead of the investor, he explained. In addition, some have argued that Regulation BI should require elimination of all conflicts of interest, but conflicts are inherent in principal-agent relationships, Clayton noted. The regulation recognizes this and requires that firms to address conflicts while and providing recommendations in the investor’s best interest, according to the chairman.

Clayton also responded to critics claiming that Regulation BI is deficient because it does not define "best interest" or require a broker to recommend the "best" security. Under the regulation, whether a broker-dealer has acted in the retail customer’s best interest depends on specific facts and circumstances, the chairman explained, and a principles-based approach can be more effective in addressing issues of duty when relationships can vary and change over time. "Many different options may in fact be in the retail investor’s best interest, and what is the ‘best’ product is likely only to be known in hindsight," he opined.

Despite the claims of certain commenters, the broker-dealer and investment adviser standards of conduct cannot be satisfied by disclosure alone, Clayton explained. Regardless of whether a conflict can be addressed through disclosure or has to be mitigated or eliminated, the conflict-of-interest obligation is just one of the components of the rule, according to the chairman. Further, while a firm may be able to satisfy the duty of care by providing disclosure and obtaining consent, this is not alone sufficient, he stated.

Regulation BI does not require broker-dealers to monitor a customer’s account or impose an ongoing duty because it is designed to preserve access to different types of services and cost structures, according to Clayton. Further, he explained that such a requirement would be inconsistent with the "solely incidental" prong of the broker-dealer exclusion; continuous monitoring of an account would subject a broker-dealer to regulation as an investment adviser, he said. The regulation takes a tailored approach that recognizes a duty to monitor would be inappropriate in the context of a transaction-based relationship, according to the chairman.

With Form CRS, each firm (broker-dealer or investment adviser) is required to provide disclosure on the same topics and in the same order, he explained. This will facilitate more meaningful comparisons among firms that are more relevant to, and easily understood by, retail investors, according to Clayton. He concluded by urging investors to use the new information and ask questions when deciding what types of services they need and how they want to pay for them.

MainStory: TopStory BrokerDealers Enforcement FiduciaryDuties InvestmentAdvisers

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