SEC Proposes ‘Best Interest’ Standard for Brokers and Their Customers

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The Securities and Exchange Commission on Wednesday approved a plan to propose  a customer “best interest” standard-of-conduct rule for brokers who make recommendations to retail customers on any securities transaction or strategy.

The proposed “Regulation Best Interest” overshadows the Department of Labor’s fiduciary rule that applies only to retirement account recommendations and that has been sidelined in part by the Trump administration.

But the new proposals were attacked at the SEC’s open meeting by Commissioner Kara Stein for failing to define what “best interest” comprises, for offering vague disclosure requirements that she said will confuse retail investors and for giving broker-dealers an effective safe harbor from litigation.

“The name of the rule, in and of itself, is confusing” said Stein, “and can cause retail investors to reasonably believe that broker-dealers are required to act in their best interests. Perhaps it would be more accurate to call this regulation Regulation Status Quo.”

The proposal does not require the strong fiduciary standard-of-care that is incumbent on investment advisers, she noted, but instead upholds the less rigorous standard that merely requires brokers to ensure that recommendations are “suitable” to a customer’s goals and risk parameters.

It thus does not require financial professional to provide retail customers with the best available investment options, she said before voting against approving the proposals.

Her four fellow commissioners approved putting the package out for comment, although several urged more clarity, particularly regarding disclosure of costs to investors. The disclosure plan would not require broker-dealers to include information to help investors distinguish between the costs to them individually of transactional and advisory accounts, several of them said.

SEC Chairman Jay Clayton defended the proposed regulatory framework as balancing what retail investors expect from their advisors with what securities laws require.

“Our framework is sound,” Clayton said in introducing a discussion of the proposals.

The SEC formally approved proposing two rules and an interpretation to address what it called in a statement “retail investor confusion about the relationships that they have with investment professionals and the harm that may result from that confusion.”  

One part of the package would restrict broker-dealers and their employees from using misleading titles such as financial advisor or adviser when communicating with investors unless they are registered under the federal Advisers Act of 1940.

Another is a proposed interpretation reaffirming, and in some cases clarifying, certain aspects of the fiduciary duty that investment advisers, as opposed to brokers, owe to clients under the fiduciary standard.

The best-interest standard for brokers contains three obligations regarding disclosure, care and conflict-of-interest. Specifically, the regulator would require brokers to:

• Disclose to retail customers the key facts about the broker-customer relationship, including material conflicts of interest;
• Understand the product or trading recommendations with enough care and skill to reasonably believe they are in a customer’s best interest; and
• Identify material conflicts of interest arising from financial incentives and, at a minimum, disclosing and mitigating them. Disclosure of other conflicts of interest also would be required.

The package of rule proposals and interpretations will be put out for a 90-day comment from the public.