Today – June 30, 2020 – is D-Day for investment brokers. It is the day when Regulation Best Interest (Regulation BI), adopted in 2019, was implemented. Though the Securities and Exchange Commission (SEC) contended Regulation Best Interest would raise the standard of care required of brokers, it was a huge disappointment for most retail investor advocates. Many in the financial services industry challenged the SEC’s authority to implement such a rule, but it was upheld last Friday by the 2nd U.S. Circuit Court of Appeals.
While this new rule is akin to a D-Day assault on the investment industry, it is difficult to say who will win the day.
Most fundamentally, it is unclear whether Regulation BI will improve the advice investors receive or further muddy the distinctions between brokers and fiduciary-bound investment advisers. This uncertainty has been heightened by monumental changes in the brokerage industry, some of which have taken place since the regulation was adopted last June.
Within days of the SEC’s ruling, the industry was already preparing itself for the new regulatory order. No longer would they operate under the Investment Advisers Act, a 1940s era regulation with restrictions on giving investment advice only when incidental to their brokerage activities. The new rule had redefined “incidental” to include just about anything a broker did. Moreover, the rule’s best interest provisions only restricted brokers from putting their own interests ahead of their clients, a seemingly insignificant semantic difference from the fiduciary requirement of putting clients’ interests first, but one can create a gaping chasm in practice and in law.
Rulemaking in the brokerage business has always been vexed by quickly shifting competitive forces. In this case it was Charles Schwab’s introduction, last fall, of zero-dollar commissions. E-Trade and TD Ameritrade Holdings Corp. quickly introduced zero-dollar commissions too. Schwab’s moves hastened the industry’s reassessment not just of its business model sans commissions, but reconsideration of where to put its people and resources. Many firms have decided the better course is to train their brokers for registration as investment adviser representatives, where they could earn fees based on the value of assets they manage for clients. This shift means many, many more investment professionals will fall under the requirements of an untested regulation.
At the same time, Regulation BI is creating challenges for the regulators themselves. Whereas the industry previously operated under decades-old rules developed and administered by the brokerage industry self-regulator – FINRA – Regulation Best Interest is a different ball game altogether. That is, FINRA will be playing by the SEC’s rules, enforcing a rule that neither has experience enforcing. Regulators and investors will no doubt face challenges as firms and individuals in the industry test the limits of acceptability in the new rule.
It also is not clear where investors will emerge from this. The competitive changes will no doubt further the decades-long reduction in trading costs and product fees, which will accrue to some extent to investors. At the same time, the trend toward industry consolidation will reduce investor options for service providers – Schwab and TD Ameritrade announced a merger late last year – and service models. Rarely have consumers benefitted from fewer choices.
Nevertheless, the fact that firms are transitioning toward registered an investment advisory business model cannot help but boost the standard for investment advice. As registered advisers, they will be bound by a common law fiduciary duty, which will lower the thresholds for investor claims on bad guidance. Again, a positive step for investors.
A lot has changed since the SEC introduced Reg BI a little more than a year ago. For supporters of a higher standard of care, the SEC’s decision represents a missed opportunity, and one that will be difficult to revisit for several years. As this new experiment in investor care begins, there are promising signs for improvement in standards of care. Let’s hope the shifting sands of the financial services industry do not defeat the promise of Regulation BI before it has the chance to storm the beach.
Jim Allen, CFA, is head of Americas capital markets policy at the CFA Institute.