Focus Perspective: SEC Standards of Conduct for Investment Professionals

On April 18, Chairman Clayton addressed an open meeting of the Commission on standards of conduct for broker-dealers and investment advisers. The Chairman outlined the objectives as three-fold:

“First, enhance retail investor protection and decision making by:

  • Raising the standard of conduct for broker-dealers when they provide recommendations to retail investors, and
  • Reaffirming and in some instances clarifying the terms of the relationships that retail investors have with their investment professionals.

Second, preserve retail investor access (in terms of choice and cost) to a variety of types of investment services and investment products.

Third, raise retail investor awareness of whether they are transacting with registered financial professionals.”

The Chairman indicated that the SEC was prompted to act due to:

Investor Confusion Regarding the Differences between Broker-Dealers (“BDs”) and Investment Advisers (“IAs”) 

Many investors do not understand the important differences between BDs and IAs, from differences in the variety of services that they offer and how investors pay for those services, to the different regulatory regimes. This confusion could cause harm if they fail to select the type of service that is appropriate for their needs, or if conflicts of interest are not adequately understood and addressed.

The Need for Standards of Conduct That Meet Reasonable Investor Expectations and Adequately Address Conflicts of Interest

Investment professionals should be held to a standard that meets reasonable investor expectations, including addressing conflicts of interest. Clarifying the legal standards of conduct that apply and reducing investor confusion through disclosure can significantly mitigate these potential harms as well as increase investor protection.

Regulatory Complexity Resulting from DOL Rule, Reduction in BD Service Offerings

The DOL tried to address some of these issues by deeming all investment professionals who provide investment advice to retirement accounts to be “fiduciaries” with respect to those accounts. During the time the rule was in effect it imposed an additional standard of conduct for broker-dealers, adding significant regulatory complexity and uncertainty in this area, including through the introduction of multiple regulatory standards to the same investor relationship.

A number of BDs limited the products or services they provided to customers, particularly customers with fewer assets, shifting customers from full-service brokerage, which includes investment advice, to discount brokerage, which does not. This reduction in service offerings has negative impacts on certain types of retail investors. It is important to preserve retail investors’ ability to choose to receive transaction-based investment advice from BDs or portfolio-based advice from IAs.

Regulatory Complexity More Generally

The Chairman’s concerns regarding regulatory complexity go well beyond the impact of the DOL rule. “There are an increasing number of inconsistencies in the standards of conduct applicable to the provision of financial advice— in regulatory text, inspection, and enforcement— and therefore, regardless of the impact of the DOL rule, the potential for increased investor confusion and harm and decreased investor choice.”

An investment professional “is subject to regulation by no less than five regulators (the SEC, FINRA, DOL, state securities regulators, and state insurance regulators). That relationship may also be subject to regulation, inspection, and enforcement by banking regulators, state attorneys general, and other state and federal regulators.”

The SEC has broad jurisdiction and relevant expertise with respect to these issues, and frequently works with state regulators, particularly on investigations and enforcement matters, and will continue to work closely with them and other regulators as it moves forward with this rulemaking.

What the SEC is Doing

The Chairman believes that the SEC can increase investor protection and the quality of investment services through a comprehensive package of rules and guidance that includes the following:

Raising and Clarifying Standards of Conduct for BDs and IAs

The SEC has proposed a rule, and a proposed interpretation, that would enhance the standard of conduct for BDs and reaffirm and clarify the standard for IAs. While the type of advice provided may be different, the obligations to the investor should be common best interest principles.

Proposed Rule: Regulation Best Interest

Disclosure – The BD must reasonably disclose to the retail customer the material facts relating to the scope and terms of the relationship, including material conflicts of interest associated with the recommendation.

Care – The BD must exercise reasonable diligence, care, skill, and prudence to understand the potential risks and rewards associated with the recommendation, have a reasonable basis to believe that the recommendation is in the best interest of the retail customer, and that a series of recommended transactions is not excessive and is in the retail customer’s best interest.

Conflicts of Interest – The BD must establish, maintain, and enforce written policies and procedures reasonably designed to identify and then to disclose or eliminate, material conflicts of interest associated with the recommendation; and disclose and mitigate, or eliminate, material conflicts of interest arising from financial incentives associated with the recommendation.

Notice of Proposed Commission Interpretation Regarding Standard of Conduct for Investment Advisers; Request for Comment on Enhancing Investment Adviser Regulation

To the extent that conduct falls below what the SEC believes the IA fiduciary duty means, this interpretation would put the market on notice of the SEC’s views.

Providing Clarity Regarding Fees, Conflicts, and other Material Matters

The SEC has proposed a rule that contains a two-pronged approach to increasing clarity for investors.

Put bluntly, we want investors to understand who they are dealing with, i.e., what category — IA, BD, or dual-hatted— their investment professional falls into and then, what that means and why it matters.”

This proposed rule will help highlight that investors are dealing with a registered entity, and that dealing with persons who are not registered raises significant risks.

Proposed Rule: Form CRS Relationship Summary; Amendments to Form ADV; Required Disclosures in Retail Communications and Restrictions on the use of Certain Names or Titles

This proposed rule has two major component obligations to address the “who” and “why” questions:

Clear Labeling. Labeling will help investors properly categorize their existing or prospective investment professional by (A) requiring BDs and IAs to be direct and clear about their legal form in communications; and (B) restricting standalone BDs and their financial professionals from using the terms “adviser” or “advisor” as part of their names or titles, which are so similar to “investment adviser” that their use may mislead prospective customers.

Fee, Conflict, and Other Material Disclosure. Disclosure will help investors understand why the legal categories matter by requiring IAs and BDs, and dual-hatted entities, to provide investors with a standardized, short-form (4 page maximum) disclosure. The disclosure will highlight key differences in: the types of services offered, the legal standards of conduct that apply, the fees the customer will pay, and certain conflicts of interest that may exist. The disclosure will also provide direction as to where and how they might get more information, including on the firm’s or investment professional’s disciplinary history.

The disclosure — on Form CRS, or “Customer/Client Relationship Summary” — is intended to advance a layered approach to disclosure.

“To help IAs and BDs, as well as retail customers, begin to visualize what Form CRS would look like, we have provided mock-up forms that would be used by standalone BDs, standalone IAs, and dually-registered firms. We are proposing to allow BDs and IAs to use electronic communications and graphics to meet their Form CRS obligations, provided that such presentations are true to the content requirements and page limits of Form CRS.”

Statements by the Chairman that have been discussed above may be found at:

Overview of the Standards of Conduct for Investment Professionals Rulemaking Package

Statement at the Open Meeting on Standards of Conduct for Investment Professionals


Focus Perspective:

This may seem to be a band aid put in place to cover the gap left by the vacating of the DOL’s rule, but we don’t have any idea of how long this proposal has been percolating internally at the SEC. This proposal certainly seems more directed to what we actually do, and depending on where you fit in the spectrum of client/customer services, there is direction aimed at you. The SEC is asking for comment on the proposed rule and the interpretation, as well as the mock-ups for Form CRS.

If you see something that you don’t like, let the SEC know. All of the comments received will be posted on the SEC’s website for our review. Although you cannot “Like” a particular comment, you can let the SEC know that you agree with comments already posted. The comment period is for 90 days, so we will have the chance to talk about some of the comments in the near future.

The proposed rule, interpretation, and Form CRS may be found here

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