Views on improving the integrity of global capital markets
19 June 2018

SEC Proposes New Conduct Rule for Broker/Dealers Offering Advice

Posted In: US SEC

As the US Department of Labor prepares to let its fiduciary duty rule die, the SEC recently proposed a new standard of conduct rule for broker/dealers who provide recommendations with respect to securities transactions, including investment strategies. Rejecting the call for a uniform fiduciary standard, the proposed Regulation Best Interest would instead require broker/dealers to meet the requirements of a “best interest” conduct standard. Such a standard would require the broker/dealer at the time of making such recommendations—then and only then—to act in the best interest of the retail customer without placing its own financial or other interest ahead of the customer’s.

The SEC has made the regulation “principles based” and has not defined this best interest conduct standard. Nevertheless, the broker/dealer will have to meet three obligations to comply with the standard.

Disclosure Obligation

To meet the Disclosure Obligation, the broker/dealer must “reasonably disclose” material facts and conflicts of interest to its client before, or at the time of, a recommendation. Interestingly, there is no requirement for “full and fair” disclosure, which applies to investment advisers and which carries a potential for liability under antifraud statutes. Favoring a “layered” disclosure approach, the SEC also separately proposes that broker/dealers use a Client Relationship Summary to supplement this disclosure requirement.

Care Obligation

Under the Care Obligation, a broker/dealer would have to exercise “reasonable” diligence, care, skill, and prudence to meet a three-part test. It would need to (a) understand the risks and rewards of what it is recommending and have a reasonable basis to believe the recommendation could be in the best interests of at least some retail customers; (b) have a reasonable basis to believe that the recommendation is in the best interest of a particular client; and (c) have a reasonable basis to believe that a series of such recommendations is not excessive and is in the client’s best interest in light of its investment profile. As an approach that will “incorporate and enhance” existing suitability requirements, this obligation cannot be satisfied through disclosure alone.

Conflict of Interest Obligation

The two-part Conflict of Interest Obligation pivots on whether the conflict of interest involves a financial incentive for the broker/dealer. If it does, the broker/dealer must have policies and procedures “reasonably designed” to identify and disclose and mitigate, or eliminate the conflict of interest. Financial incentives can include, among other things, sales contests, quotas, differential or variable compensation, and sales of proprietary products. For material conflicts of interest not associated with financial incentives, the broker/dealer’s policies and procedures would aim to identify and disclose, or eliminate, these conflicts.

CFA Institute Position

CFA Institute has long urged the SEC to adopt a uniform standard of conduct for all who provide personalized investment advice to retail investors. Thus, although CFA Institute is pleased that the SEC has proposed a standard, we are disappointed it has created yet an additional standard — the best interest standard — for essentially the same activities for which investment advisers already are held to under a fiduciary duty standard of conduct.

How a best interest standard would actually work and the protections it would provide investors is less than clear. Instead, to preserve the existing broker/dealer business model, the SEC invests broker/dealers with broad discretion and flexibility to determine if and when they must take action, and the form that action should assume. In fact, in many ways, the proposed standard seems more akin to an enhanced suitability, rather than a best interest, standard.

Given the many strong reactions, CFA Institute expects a robust comment process that will provide the SEC with constructive advice for shoring up this standard. At the very least, we believe that if investors are told they are investing with their broker/dealers under a best interest standard, they deserve to know that their interests actually come first.

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Photo Credit: ©Getty Images/Mevans

About the Author(s)
Linda Rittenhouse, JD

Linda Rittenhouse, JD, was a director of capital markets policy at CFA Institute. She focused primarily on issues related to investment products and investment regulation. Rittenhouse holds a JD degree.

1 thought on “SEC Proposes New Conduct Rule for Broker/Dealers Offering Advice”

  1. Hazel Owens says:

    That’s interesting that for the care obligation standard that a broker/dealer would have to exercise “reasonable” diligence, care, skill, and prudence in order to pass a three-part test. This is interesting since its goal is to incorporate and enhance existing suitability requirements that cannot be satisfied through a disclosure alone. This a smart tactic since it would ensure that the broker/dealer would care for their client and would have the skills and diligence to take all things into consideration when working.

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