Broker-Dealer Standard of Care: The SEC Enters the Fray

Broker-Dealer Compliance + Regulation

At an open meeting held earlier today, April 18, 2018, the SEC voted 4-1 to propose a package of rules, forms, and guidance designed to define a new “best interest” standard of care for broker-dealers dealing with retail investors. The proposal would also require disclosure designed to help retail investors understand their relationship with their investment professionals, and to clarify the existing fiduciary standard of care applicable to investment advisers.

Chairman Clayton notably characterized the proposals as an “important step” forward. However, it is not a panacea to fully address lingering confusion among retail investors about the differing obligations of investment professionals who deal with retail investors. Even Commissioners voting in favor of the rule acknowledged that changes to the proposals were likely.

Summary of the Proposals

In releases totaling more than 1,000 pages, including more than 1,800 footnotes, the SEC voted to propose for comment:

  • Regulation “Best Interest,” which will purportedly establish a standard of conduct applicable to broker-dealers and their registered representatives when dealing with retail investors. Notably, however, and much to the dismay of the proposal’s critics, the regulation as proposed does not define the term “best interest.” Among other things, Regulation BI will make it clear that broker-dealers cannot place their own interests above those of their clients. It will require broker-dealers to provide clients with written disclosure of the material facts related to the broker-dealer relationship, including fees and material conflicts of interest, and will require that broker-dealers adopt and implement reasonable policies and procedures designed to disclose and eliminate or mitigate material conflicts of interest arising from the broker-dealer’s financial incentives.
  • Form CRS, a client relationship summary designed to be a “simple point-of-entry” document for registered broker-dealers and registered investment advisers to provide to retail investors. As proposed, Form CRS would be limited to four pages that would provide reasonable disclosure of the relationship between an investment professional and its clients, including an outline of the types of services to be provided by the investment professional, the fees payable for those services, material conflicts of interest, and the relevant standard of care. In addition, as proposed, Form CRS will include key questions that retail investors may want to ask of their investment professionals in order to better understand the relationship and the relevant standard of care. The proposal will also limit a broker-dealer’s ability to identify itself as an “adviser” or an “advisor” unless the broker-dealer is dually registered with the SEC as an investment adviser.
  • SEC guidance interpreting the existing fiduciary standard of care applicable to investment advisers. The staff noted that the federal fiduciary standard is primarily a creature of common law that is shaped through full and fair disclosure, the specifics of which can vary from client to client. The proposed guidance would collect existing guidance in one place and summarize the SEC’s interpretation of that guidance. The release will also seek comment on whether the SEC should propose enhancements to investment advisers’ registration obligations including licensing and continuing education standards, requirements for investment advisers to provide account statements, or requirements for net capital standards applicable to investment advisers.

Issues to Consider

As Commissioner Piwowar stated in his remarks regarding the proposed best interest standard, it “sounds simple enough but the devil is in the details” and, over the coming days, we will take a deeper dive into the details of the proposals. In the meantime, however, here are some key questions that broker-dealers and investment advisers may want to consider when reviewing the proposals:

  • The proposed broker-dealer best interest standard purports to be different from the fiduciary standard applicable to investment advisers and from the existing FINRA suitability standard applicable to broker-dealers; however there appears to be a meaningful amount of overlap among those three standards. That ambiguity could confuse retail investors, and could also result in significant differences among compliance approaches among the broker-dealer community.
    • Will the need for new and enhanced policies and procedures increase the cost of compliance for broker-dealers, such that some broker-dealers may opt to leave the retail business?
  • One of the goals of the proposals is to preserve for retail investors the ability to decide how and where to seek their investment advice. In particular, the proposal seeks to preserve the pay-as-you-go transaction based compensation structure favored by broker-dealers and the asset-based fee structure favored by investment advisers.
    • Does the combination of a best interest standard, which is based in large part upon the fiduciary standard applicable to advisers, and possibly imposing on advisers certain net capital and licensing requirements similar to those currently applicable to broker-dealers start to blur the line between the two types of firms? Will this exacerbate the decline of retail broker-dealers? Is that in the best interest of retail investors?
  • The Form CRS and Regulation BI are additive disclosure, and retail investors already struggle to understand the pages of disclosure they receive when making an investment.
    • How can Form CRS, in particular, be designed to better communicate the key components of the relationship between an investment professional and its clients?  Should this include both form (including whether electronic delivery should be expanded to fully take advantage of new ways to deliver information) and content?
  • As noted by some of the Commissioners, many investment advisers follow industry standards when evaluating their compliance with their existing fiduciary duties. Some established industry standards, however, are the result of settled enforcement matters, rather than based in existing law or regulation.
    • Investment advisers should consider if some of the SEC’s proposed interpretations are supported by regulation. If not, should be the SEC be required to propose new regulations rather than simply issuing interpretive guidance?
  • Regulation BI and Form CRS each will require certain disclosures to retail clients. Form CRS is designed as a high-level summary but Regulation BE will require certain written disclosures of the scope and terms of the relationship.
    • Can Regulation BI and Form CRS be better integrated to limit the amount of new disclosure required to be provided to retail investors or to make it more understandable?


Needless to say, we expect that the financial community will exert significant effort to fully evaluate the potential impact of the proposals. And of course, we also expect a great deal of public debate as to the pros and cons of the proposals, especially when viewed in light of the more prescriptive Department of Labor rules.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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