Fi360 Client Alert and Analysis - Reg BI Cometh!

May 28, 2019

It’s official – the SEC Commissioners will meet June 5 at 10:00 a.m. EDT to tackle four items of great significance to registered investment advisers, broker-dealers and retail (non-institutional) investors. Item 1 is the headline event: a vote on whether to adopt Regulation Best Interest, or Reg BI. That’s the shorthand title of the Commission’s previously released proposal “to establish a standard of conduct for broker-dealers and natural persons who are associated persons of a broker-dealer when making a recommendation to a retail customer of any securities transaction or investment strategy involving securities.”

Items 2 and 3 relate to proposals that accompanied Reg BI in the initial release on April 18, 2018. The Commission will vote on whether to adopt rules and forms to require RIAs and broker-dealers to provide a brief “client relationship summary” (Form CRS) to retail investors (Item 2 on the agenda) and publish a Commission interpretation of the existing standard of conduct for RIAs (Item 3).

Item 4 comes as a complete and intriguing surprise. The Commission will decide whether to publish an “interpretation of the solely incidental prong of section 202(a)(11)(C) of the Investment Advisers Act of 1940.” This “incidental advice” provision of the ’40 Act is the loop-hole that allows advice of ill-defined quantity, type and substance without triggering the need for a broker-dealer to register as an investment adviser with the SEC. Some would argue that this is the main source of confusion between non-fiduciary and fiduciary standards of conduct that apply to advice from broker-dealers and RIAs, respectively.

We will stop short of making specific predictions about what the SEC will do, but you can count on a fast, full and factual recap and analysis of what happens on June 5 within days of the Commission’s actions. For now, we will conclude with a few quick thoughts on each of the four agenda items the Commissioners will address.

  1. Reg BI is a priority of SEC Chair Jay Clayton. It is inconceivable that Clayton would schedule the meeting if he had any uncertainty about the regulation being formally approved at this meeting. That doesn’t mean it will take immediate effect; there will be effective and enforcement dates that will define when firms will need to comply with the rule. Changes proposed in the final version versus what was in the original will capture everyone’s attention.
  2. Form CRS in its original state was widely and justifiably maligned as adding to investor confusion about standards of conduct applicable to brokers and advisers. It would be a miraculous accomplishment for the SEC to have corrected this document sufficiently to satisfy stakeholders without a major overhaul and additional rounds of comment. That doesn’t mean that the SEC won’t try to declare it final, or kill it altogether, but some path that involves more study and work over an extended time period is what is needed. Also note that what the Commissioners decide to do on Item 4 could make Form CRS unnecessary.
  3. The Commission’s interpretation of the existing standard of conduct for RIAs is the least controversial of the topics on the docket for the day. It’s largely a tabulation of existing facts and guidance. Although this is the least controversial part of the overall package, consumer advocates have expressed concern that the guidance may allow RIAs to rely on disclosure to mitigate a conflict of interest without assuring that the investor’s best interests are served. 
  4. Item 4 – we can’t wait to see what this is about. The SEC asked a number of questions in its proposed release about the solely incidental prong of the exemption for broker-dealers, mostly centered around discretionary trading authority.  One of those questions asked whether the agency should propose an interpretive rule “placing express limits on investment discretion.”  The vast majority of dually registered brokerage firms only offer discretionary management in advisory accounts.  Other than consensus around this practice, it’s hard to imagine that the SEC can come up with a way to make the incidental advice provision worse or more counterproductive to investor protection than it already is. A more practical approach would be clarification that advice that is personalized and suggestive of fiduciary obligations should trigger registration as an investment adviser. Perhaps that’s wishful thinking, but narrowing the meaning of “incidental” seems to be the most logical approach as it would help make Items 1 through 3 much more manageable and acceptable to consumer advocates.

Stay tuned, there will be much more to come from Fi360 as events unfold.