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The SEC recently adopted new rules to help protect investors from bad advice, high fees and conflicts of interest when buying investment products from financial advisors. Under the new rules, financial advisors who earn commissions (brokers) will be held to a higher standard of conduct when recommending investment products such as IRAs and 529 plans.
The proposal includes three components:
- Regulation Best Interest (Reg BI) – new rules for broker-dealers, including disclosure of conflicts of interests and considering costs when recommending products
- Form CRS Relationship Summary – new disclosures for initial meetings of investors with broker-dealers and investment advisors
- Interpretation of existing laws under the Investment Advisers Act of 1040 – clarifies the fiduciary duty of an investment advisor
Existing Standards of Conduct
The new regulations build on the existing standards of conduct that brokers and investment advisors are currently held to, which include a suitability standard and a fiduciary duty standard (best interests).
Broker-dealers are held to a suitability standard, which is enforced by the Financial Industry Regulatory Authority (FINRA). Under the suitability standard, broker-dealers must have a reasonable basis to believe that their recommendations are suitable for the client based on the client’s needs and their investment profile.
However, a suitable recommendation isn’t necessarily the best recommendation for a client. Financial advisors who work for broker-dealers are typically fee-based advisors, who may earn commission on the products they sell to clients.
Registered Investment Advisors (RIAs) have a fiduciary duty to put their client’s best interests first. The Fiduciary Standard was created as part of the Investment Advisers Act of 1940 and is regulated by the SEC. Fiduciaries are held to a higher standard than broker-dealers. A fiduciary financial advisor is required to:
- Put their clients’ interests above their own interests
- Avoid conflicts of interest and disclose of any potential conflicts of interest to clients
- Not use clients’ assets for their own benefit or for the benefit of other clients
Many RIAs operate as fee-only. Fee-only financial advisors are paid for advice, and do not earn commissions on products they sell. They may be paid hourly, by retainer, as a percentage of the client’s assets under management or a flat fee.
The DOL Fiduciary Rule was first introduced under the Obama administration and was scheduled to go in effect in April 2017 but was delayed until June 9, 2017. The rule was overturned by a court decision in June 2018.
The DOL Fiduciary Rule would have required all advisors, including brokers and RIAs, to act as fiduciaries when advising clients on retirement planning. The DOL plans to introduce a new version of the Fiduciary Rule in December 2019, which will be a collaboration with Reg BI.
New Standards of Conduct adopted by the SEC
The new rules and interpretations adopted by the SEC apply to financial advisors who work for broker-dealer firms and investment advisors.
Regulation Best Interest requires broker-dealers to provide disclosures regarding their fees and services, consider costs when recommending products to clients and disclose or eliminate any conflicts of interest. Examples of conflict of interest include offering only proprietary products and sales contests and sales quotas for specific products.
Form CRS Relationship Summary will be required during an investor’s initial meeting with a broker-dealer or investment advisor. The relationship summary, Form CRS, is intended to help consumers make informed decisions, and includes information about the services, fees and costs, conflicts of interest and legal standard of conduct of the financial advisor and their firm. It also includes any disciplinary history of firm and its advisors.
New interpretations reaffirm existing laws under the Investment Advisers Act of 1940. This includes clarification of the federal fiduciary duty of an investment advisor to their clients and the “Solely Incidental” interpretation, which exempts certain broker-dealers from the definition of an Investment Advisor.
Reg BI and Form CRS become effective 60 days after they are published in the Federal Register, and firms have until June 30, 2020 to comply. The interpretations under the Investment Advisers Act of 1940 are effective upon publication in the Federal Register.
Will the new SEC rules better protect investors?
Critics of Reg BI claim that the proposal doesn’t exactly define best interest and doesn’t eliminate conflicts interest. New Jersey, Nevada and, most recently, Massachusetts are not satisfied with Reg BI and have proposed their own fiduciary rules.
But, even without the new rules, there are many financial advisors who already put clients’ needs first. To find a fiduciary financial advisor, investors should:
- Look for fee-only (not fee-based) financial advisor
- Look up the advisor on the SEC’s Investment Adviser Public Disclosure website
- Find an investment advisor through The National Association of Personal Financial Advisors (NAPFA)
- Make sure the investment advisor is not dually registered as a broker-dealer
