Investors Win with New SEC 'Best Interest' Rules on Brokers

Here's some good news for investors: Stronger SEC rules protecting their best interests went into effect on Sept. 10, 2019. Firms have until June 30, 2020, to come into compliance, but here's a look at what's changing.

(Image credit: Kiko Jimenez (Kiko Jimenez (Photographer) - [None])

The Securities and Exchange Commission (SEC) recently approved a consumer-friendly package of Best Interest Rules that require brokerage firms to disclose potential conflicts of interest when giving financial guidance to consumers.

The new requirements provide stronger protections and transparency for clients of investment advisers and broker-dealers. Officially known as the SEC Regulation Best Interest: The Broker-Dealer Standard of Conduct (opens in new tab), the new rules raise the bar on the broker-dealer standard of conduct beyond existing “suitability” obligations. The suitability standard meant that investments or products that brokers recommended for clients needed to be merely “suitable” for their goals, but not necessarily the best choice or the one with the lowest fees.

The new higher standard of conduct going into effect draws from key fiduciary principles, although they stop short of mandating full fiduciary duties (a requirement that registered investment advisers must meet). The rules require brokers to raise the standard to meet a client’s best interest and avoid potential conflicts when recommending stocks, mutual funds and other financial products. Such conflicts might involve the fees investors pay, or the commissions brokers earn, for professional advice on investment strategies and decisions.

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Under Regulation Best Interest, broker-dealers will be required to act in the best interest of a client when making a recommendation of any securities transaction or investment strategy involving securities. The rules make it clear that a broker-dealer may not put its financial interests ahead of the interests of a retail customer when making recommendations. These SEC actions should help clarify the standards of conduct for broker-dealers and investment advisers, thus giving investors a better understanding to compare services and make informed choices regarding financial recommendations.

Disclosure Obligations Increase Transparency

As these rules take effect, registered investment advisers and broker-dealers will need to provide retail investors with simple, easy-to-understand information about the nature of their relationship with their financial professionals. Here is a short summary of the various elements:

Disclosure Obligation:

Broker-dealers must disclose specific facts about the relationship and recommendations, including fees and the type and scope of services provided. They must reveal any conflicts, limitations on services or products, and whether the broker-dealer provides monitoring services.

Care Obligation:

A broker-dealer must exercise reasonable diligence and care when making a recommendation to an investor. The broker-dealer must understand potential risks, rewards and costs associated with the recommendation. The broker-dealer must then consider these factors in terms of the retail customer’s investment profile and make a recommendation in the retail customer’s best interest.

Conflict of Interest Obligation:

The broker-dealer must establish and enforce written policies and procedures designed to identify and eliminate conflicts of interest. This obligation specifically requires actions to:

  • Mitigate conflicts that create an incentive for the firm’s financial professionals to place their interest or the interests of the firm ahead of the retail customer’s interest;
  • Prevent limitations on offerings, such as a limited product menu or offering only proprietary products, from causing the firm or its financial professional to place his or her interest or the interests of the firm ahead of the retail customer’s interest; and
  • Eliminate sales contests, sales quotas, bonuses and non-cash compensation that are based on the sale of specific securities or specific types of securities within a limited period of time.

In addition, a new Form CRS Relationship Summary will require registered investment advisers and broker-dealers to provide retail investors with simple, easy-to-understand information about the nature of their relationship with their financial professionals.

The format of the relationship summary allows for comparability among two different types of firms. Form CRS will also include a link to a dedicated page on the SEC’s investor education website, (opens in new tab), which offers educational information about broker-dealers and investment advisers.

New Rules to Require Updated Compliance Platforms

The Commission recognizes that these new rules will require various market participants to change their operations, including mandatory disclosures, marketing materials and compliance systems.

Regulators are focusing on advisers who use personal email account, instant messages and texts to send business-related communication to customers for securities-related correspondence. In many cases, these online conversations involve excessive trading and unsuitable recommendations involving the use of margin and undisclosed personal email accounts and text messages to conduct securities business.

There are many examples of brokers using unauthorized accounts to conduct securities business that resulted in huge fines and penalties for the firm and the broker. In one case, a broker was fined $5,000 for using unapproved text messaging (opens in new tab) to communicate with a customer to conduct securities business. He regularly corresponded with his firm’s customers via texts regarding securities activity in their accounts.

What Consumers Should Do to Benefit from New Rules

Consumers can take advantage of the SEC Best Interest rules to protect themselves from such instances at their advisory firms. Here’s how:

  • Be sure to ask your financial adviser about their practices and what measures they have in place to comply with the SEC Best Interest rules.
  • Ask your financial adviser if they are a fiduciary. If they are, get them to put in writing that they act as a fiduciary.
  • Inquire about the compensation model and disclosures.
  • Also, ask your adviser which applications they use to communicate with customers via text, email, IM and collaborative work applications.
  • Don’t be afraid to ask about the supervisory policies they have in place when conducting client business.

Failing to comply with the SEC Best Interest rules and other SEC and FINRA supervisory and retention obligations can mean serious consequences for firms and their employees. This newest level of accountability will help ensure that all client communications are on the record and can be investigated for misconduct, creating a big win for investor trust and broker accountability.

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

Marianna Shafir, Esq.
Corporate Counsel and Regulatory Advisor, Smarsh

Marianna Shafir, Esq. is Corporate Counsel and Regulatory Advisor at Smarsh (opens in new tab), a leader in comprehensive digital archiving.