The SEC proposed to (i) require broker-dealers to act in the “best interests” of retail customers when making a recommendation of any securities transaction or investment strategy and (ii) affirm and clarify the various types of obligations that investment advisers owe to their clients. The proposal was approved by a four-to-one vote. SEC Commissioner Kara M. Stein dissented.
Under Regulation Best Interest, a broker-dealer would not be permitted to place its own interests ahead of those of its retail clients. The proposed regulation provides that a broker-dealer will satisfy the best interest standard if it complies with the following obligations:
- Disclosure: disclose material information about the relationship with the retail customer, including material conflicts of interest;
- Care: act with 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”; and
- Conflict of Interest: implement policies and procedures reasonably designed to identify and address conflicts of interest arising from financial incentives, and to disclose any other material conflicts of interest.
The SEC stated that the “Commission believes that material conflicts of interest associated with the broker-dealer relationship need to be well understood by the retail customer and, in some cases, mitigated or eliminated” [at fn 17].
As to litigation that might arise under Regulation Best Interest, the release states that the Regulation “would not alter a broker-dealer’s obligations under the general antifraud provisions of the federal securities laws . . . [nor would it] create any new private right of action.” On the other hand, the SEC stated, “scienter would not be required to establish a violation of Regulation Best Interest.” Further, “as compared to a broker-dealer’s existing suitability obligations under the antifraud provisions of the federal securities laws . . . a broker-dealer would not be able to satisfy its ‘Care Obligation’ . . . through disclosure alone.”
In addition, the SEC proposed an interpretation reaffirming and/or clarifying certain aspects of the fiduciary duty that investment advisers owe to their clients. These duties owed by an adviser to a customer include (i) a “duty of care” (including the obligation to provide advice in the client’s best interest, a duty to seek best execution, and a duty to provide advice and monitoring over the course of the relationship) and (ii) a “duty of loyalty.” The SEC also asked for comments as to whether adviser regulation should be expanded so that it mirrors broker-dealer regulation. In particular, the SEC requested comments as to whether (i) the employees of investment advisers should be subject to federal licensing and qualification requirements; (ii) advisers should be required to provide more detailed statements of the fees that they charge; and (iii) advisers should be either subject to capital requirements or forced to obtain fidelity bonds that might compensate clients for losses due to the advisers’ misconduct.
Finally, the SEC proposed a rule that would require broker-dealers and investment advisers to provide retail investors with a short-form “relationship summary” detailing (i) certain information related to services offered, including the legal standard that applies to each type, (ii) associated fees, and (iii) conflicts of interest.
There will be a 90-day public comment period on these proposed rules and interpretations after their publication in the Federal Register.
Lofchie Comment: There is quite a lot here (the Release for Regulation Best Interest tops 400 pages), including a good deal that could have a significant effect on the products that firms offer and the way in which broker-dealers conduct business. For example, broker-dealers will need to examine closely (i) the types of products that they offer (particularly proprietary, complex or structured products), (ii) the manner in which they compensate their employees, (iii) the manner in which they charge fees to their customers and (iv) the provision of different benefits to different customers (see pages 53-4).
The obligations that may be imposed on advisers, though not fundamentally different than those that are understood to exist today, may have been increased. The Fiduciary Release (which runs a mere 38 pages) says at page 21 that they have not been increased; just clarified. However, the release suggests the possibility for significantly expanded private rights of action and litigation under the Advisers Act. For example, the Advisers Act is described as having “establishe[d] a federal fiduciary standard for investment advisers” (fn. 10) . . . that is “made enforceable by the antifraud provisions of the Advisers Act.” As to the specific duties imposed on advisers, firms should consider, for example, (i) their obligations to obtain information regarding each client’s situation through the “client investment profile,” (ii) their obligation to provide investment advice that takes account of the client’s entire circumstances (going beyond the particular investments recommended or purchased), and (iii) the adviser’s obligation to provide advice to a client “at a frequency that is both in the best interest of the client and consistent with the scope of advisory services agreed. . . . The duty to provide advice and monitoring is particularly important for an adviser that has an ongoing relationship with a client.”