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SEC Final Rules Regarding Conduct for Broker-Dealers & Investment Advisers

Written By:

Published On: June 21, 2019

   On June 5, 2019, the Securities and Exchange Commission (“SEC”) approved new Rules and interpretations regarding the standards of conduct of broker-dealers (“BD”) and investment advisers (“IA”). The rules and interpretations were adopted pursuant to a grant of rulemaking authority in Section 913(f) of the Dodd-Frank Act and reflect a heightened standard for quality and transparency, enhancing the investors’ relationship with BDs and IAs.

            The rules and interpretations are:

  1. Regulation Best Interest: The Broker-Dealer Standard of Conduct (“Reg BI”).
  2. Form CRS Relationship Summary; Amendments to Form ADV (“Form CRS”).
  3. Commission Interpretation Regarding Standard of Conduct for Investment Advisers (“IA Conduct Interpretation”).
  4. Commission Interpretation Regarding the Solely Incidental Prong of the Broker-Dealer Exclusion from the Definition of Investment Adviser (“BD Exclusion Interpretation”).

I.   Regulation Best Interest

   Reg BI provides a new standard of conduct for BDs when making recommendations of securities transactions or providing investment strategy involving securities to a retail customer. The rule requires BDs to act in the “best interest” of their customers and place the interests of their customers ahead of their own or other interests. Broker-dealers must comply with four obligations when making recommendations to satisfy Reg BI. These four obligations are: (1) a disclosure obligation; (2) a care obligation; (3) a conflict of interest obligation; and (4) a compliance obligation.

   The disclosure obligation requires the BD to provide in writing full and fair disclosure of (1) all material facts relating to the scope and terms of the relationship as well as (2) all material facts relating to conflicts of interest associated with the recommendation.

   The care obligation requires BDs to exercise reasonable diligence, care and skill to (1) understand the risks, rewards, and costs associated with the recommendation and have a reasonable basis to believe that the recommendation is in the best interest of the customer; (2) have a reasonable basis to believe that the recommendation is in the best interest of a particular retail customer based on the customer’s investment profile; and (3) have a reasonable basis to believe that a series of recommended transactions is not excessive and is in the best interest of the retail customer.

   The conflict of interest obligation requires (1) identification and at a minimum disclosure or elimination of all conflicts of interests associated with such recommendations; (2) identify and mitigate any conflicts of interests that create an incentive for associated persons (“AP”) to place the other interests ahead of the interests of the customer; (3)(i) identify and disclosure any material limitations on the securities, and (ii) prevent such limitations and conflicts from causing the BD or AP to put other interests ahead of the interests of the customer; and (4) identify and eliminate any sales contests, sales quotas, bonuses, and non-cash compensation that are based on the sales specific securities or specific types of securities within a limited period of time.  

   Finally, the compliance obligation requires the BD to establish, maintain, and enforce policies and procedures reasonably designed to achieve compliance with Reg BI.

II.   Form CRS

   Form CRS requires both BDs and IAs to provide retail investors with a short relationship summary document that provides certain information about the firm and the brokerage and/or investment advisor services it offers, including fees and costs, conflicts of interest, and whether or not the firm and its professionals have been disciplined. The Form CRS also includes specific instructions as to content, formatting, and length.

III.   IA Conduct Interpretation

   The IA Conduct Interpretation was issued to reaffirm and clarify its views on the fiduciary duties that investment advisers owe to their clients, including the Duty of Care and the Duty of Loyalty. This will apply to all investment advisers whether they are registered and/or have retail customers.

   Under the duty of care, IAs have additional duties such as, the duty to provide advice that is in the Best Interests of the Client, the Duty to Seek Best Execution, and the Duty to Provide Advice and Monitoring over the Course of the Relationship. Each of these three duties place an emphasis on the IA putting the interests of their customers before their own or other interests.

IV.   BD Exclusion Interpretation

   The BD Exclusion Interpretation clarifies the scope of the BD exclusion from the definition of “investment adviser” in the Investment Advisers Act of 1940. The SEC realized that this exclusion allowed BDs to provide substantial amounts of investment advice and therefore it set out clear definitive limits to this exclusion.

   These limits include limitations on when a BD may exercise investment discretion and provide investment advice, which is only when it is in connection with their business to buy and sell securities. The investment advice cannot be the main goal of the transaction.

   The SEC also clarified that a BD may voluntarily and without any agreement with the customer review the holdings in a customer’s account for purposes of deciding whether to make an investment recommendation a