The SEC has proposed two rules and an interpretation to address retail investor confusion about the relationships that they have with investment professionals and the harm that may result from that confusion. Confusion has resulted from differing standards applied to broker-dealers and investment advisers.

As a result of the proposed rules, the SEC will consider strengthening the standard of conduct that broker-dealers owe to their customers. The proposed rules also reaffirm and, in some cases, clarify, the standard of conduct that investment advisers owe to their clients. The SEC believes the proposed rules also provide additional transparency and clarity for investors through enhanced disclosure designed to help them understand who they are dealing with, and why that matters.  According to the SEC, the rulemaking package seeks to enhance investor protections while preserving retail customer access to transaction-based brokerage accounts and a broad range of investment products.

When adopting the proposed rules, SEC Chair Jay Clayton discussed the so called “fiduciary rule” adopted by the Department of Labor which was cast into doubt following a ruling by the Fifth Circuit of the Court of Appeals. According to Chair Clayton, the DOL action and other developments drove significant change in the market for investment advice. A number of broker-dealers limited the products or services they provide to customers, particularly those customers with fewer assets. More specifically with respect to those services, some broker dealers shifted customers from full-service brokerage, which includes investment advice, to discount brokerage, which does not. Other firms that are dually registered as both broker-dealers and investment advisers, as well as broker dealers that have an affiliated investment advisers, shifted customers into advisory accounts, where, depending on the customer’s investment strategy, they may pay more in fees for advice and services. Chair Clayton believes this reduction in transaction-based service offerings has, and will continue to have, negative impacts on certain types of retail investors — for example, for buy-and-hold investors that transact infrequently, a brokerage account may be a more appropriate and potentially less expensive account option.

A short summary of the proposed rules and interpretation follows.

Regulation Best Interest

Under the proposed rules, a broker-dealer making a recommendation to a retail customer would have a duty to act in the best interest of the retail customer at the time the recommendation is made, without putting the financial or other interest of the broker-dealer ahead of the retail customer.

A broker-dealer would discharge this duty by complying with each of three specific obligations:

• Disclosure obligation: disclose to the retail customer the key facts about the relationship, including material conflicts of interest.
• Care obligation: exercise reasonable diligence, care, skill, and prudence, to (i) understand the product; (ii) have a reasonable basis to believe that the product is in the retail customer’s best interest; and (iii) have a reasonable basis to believe that a series of transactions is in the retail customer’s best interest.
• Conflict of interest obligation: establish, maintain and enforce policies and procedures reasonably designed to identify and then at a minimum to disclose and mitigate, or eliminate, material conflicts of interest arising from financial incentives; other material conflicts of interest must be at least disclosed.

Investment Adviser Interpretation

An investment adviser owes a fiduciary duty to its clients — a duty that the Supreme Court found exists within the Advisers Act. The proposed interpretation reaffirms, and in some cases clarifies, certain aspects of the fiduciary duty that an investment adviser owes to its clients.

Form CRS – Relationship Summary

Investment advisers and broker-dealers, and their respective associated persons, would be required to provide retail investors a relationship summary. This standardized, short-form (4 page maximum) proposed disclosure would highlight key differences in the principal types of services offered, the legal standards of conduct that apply to each, the fees a customer might pay, and certain conflicts of interest that may exist.

Investment advisers and broker-dealers, and the financial professionals who work for them, would be required to be direct and clear about their registration status in communications with investors and prospective investors. Certain broker-dealers, and their associated persons, would be restricted from using, as part of their name or title, the terms “adviser” and “advisor” — which are so similar to “investment adviser” that their use may mislead retail customers into believing their firm or professional is a registered investment adviser.