The new rules are designed to enhance investor protections while preserving retail investor access and choice in: (1) the type of professional with whom they work, (2) the services they receive, and (3) how they pay for these services.
To accomplish these goals, the rules will enhance the standard of conduct that broker-dealers owe to their customers and align the standard of conduct with retail customers’ reasonable expectations. In addition, the rules aim to provide additional transparency and clarity for retail investors through enhanced disclosures designed to help them understand who they are dealing with, and why that matters. This is accomplished by two tools:
1: Regulation Best Interest
Regulation Best Interest states that “[a] broker, dealer, or natural person who is an associated person of a broker or dealer, when making a recommendation of any securities transaction or investment strategy involving securities (including account recommendations) to a retail customer, shall act in the best interest of the retail customer at the time the recommendation is made, without placing the financial or other interest of the broker, dealer, or natural person who is an associated person of a broker or dealer making the recommendation ahead of the interest of the retail customer.” This best interest obligation is satisfied if a broker or dealer satisfies the following obligations:
Disclosure Obligation: Requires full and fair disclosure of all material facts relating to the scope and terms of the relationship with the retail customer and all the material facts relating to conflicts of interest that are associated with the recommendation.
Care Obligation: Requires the exercise of reasonable diligence, care, and skill to: (1) understand the potential risks, rewards, and costs associated with a recommendation, (2) have a reasonable basis to believe that the recommendation could be in the best interest of at least some retail customers, (3) have a reasonable basis to believe that the recommendation is in the best interest of a particular retail customer based on that retail customer’s investment profile, and (4) have a reasonable basis to believe that a series of recommended transactions, even if in the retail customer’s best interest when viewed in isolation, is not excessive and is in the retail customer’s best interest when taken together in light of the retail customer’s investment profile.
Conflict of Interest Obligation: Requires brokers or dealers to establish, maintain, and enforce written policies and procedures reasonably designed to: (1) identify and at a minimum disclose all conflicts of interest associated with such recommendations, (2) identify and mitigate any conflicts of interest associated with such recommendation that create an incentive for a natural person who is an associated person of a broker or dealer to place the interest of the broker, dealer, or such natural person ahead of the interest of the retail customer, (3) identify and disclose any material limitations placed on the securities or investment strategies involving securities that may be recommended to a retail customer and any conflicts of interest associated with such limitations, while preventing such limitations and associated conflicts of interest from causing the broker, dealer, or associated person to make recommendations that place their interest ahead of the interest of the retail customer, and (4) identify and eliminate any sales contests, sales quotas, bonuses, an non-cash compensation that are based on the sales of specific securities or specific types of securities within a limited period of time.
Compliance Obligation: Requires the establishment, maintenance, and enforcement of written policies and procedures reasonably designed to achieve compliance with Regulation Best Interest.
2: Form CRS Relationship Summary
At the beginning of a relationship with a retail customer, investment advisers and broker-dealers will be required to deliver to such customer Form CRS, which summarizes information about services, fees and costs, conflicts of interest, legal standard of conduct, and whether or not the firm and its financial professionals have a disciplinary history.
With the regulations becoming effective 60 days after their publication in the Federal Register and full compliance with the rule being mandated by June 30, 2020, we look forward to additional interpretations of the rulemaking package by the Commission, and will keep you updated on any further developments.