A landmark regulation designed to change the way brokers deliver investment advice is within weeks of going into force. It’s a milestone that so far is being observed quietly.
Regulation Best Interest must be implemented at financial advisory firms by June 30. Approved a year ago by the Securities and Exchange Commission as part of an advice-reform regulatory package, the measure prohibits brokers from placing their financial interests ahead of those of their clients.
The SEC developed Reg BI as the Department of Labor’s fiduciary rule began faltering at the beginning of the Trump administration. The DOL regulation, which would have applied a fiduciary standard to advice in retirement accounts, was vacated by a federal appeals court in 2018.
But in the months between the spring of 2016, when the Obama administration finalized the DOL rule, and early 2017, before President Donald Trump was sworn in, there was a swirl of activity in the financial industry to prepare for the measure.
Mutual funds that leveed compensation paid to brokers or eliminated fees for distribution — known as clean shares and T-shares — were introduced. Brokerages announced major policy changes, such as converting individual retirement accounts to advisory accounts, lowering asset minimums for advisory accounts, reducing costs for exchange-traded funds and adhering to the strictures of the DOL rule in brokerage accounts.
In contrast to that commotion over the DOL rule, it’s been mostly crickets from the brokerage industry when it comes to announcements of concrete changes firms are making in adviser compensation, product lineups and other aspects of the adviser-client relationship in preparation for Reg BI.
The Consumer Federation of America, which compiled a report in early 2017 on the changes the DOL rule had catalyzed, has noticed the much quieter atmosphere as the advent of Reg BI approaches.
“Now, it’s practically radio silence,” said Barbara Roper, director of investor protection at the Consumer Federation of America. “The kind of dramatic changes to how firms were going to compensate their salespeople hasn’t been as evident this time around. The best that can be said about [Reg BI] is that it was designed to bring about incremental changes.”
The DOL rule struck more fear in the heart of the brokerage industry, said Duane Thompson, senior policy analyst for Fi360, a fiduciary education and technology firm.
“I guess the ‘F word’ — fiduciary — had more meaning than best interest,” Thompson said.
After decades of debate over investment advice standards, the SEC decided to continue to regulate brokers and investment advisers separately. Brokers will be governed by Reg BI, which the SEC says is stronger than the current suitability standard, while investment advisers will continue to owe their clients fiduciary duty.
The SEC maintained the June 30 implementation date for Reg BI despite the fact that the coronavirus pandemic has disrupted brokerage operations. In risk alerts published in early April, the agency indicated that it expects firms to make a “good faith effort” and “reasonable progress” in putting in place policies and procedures to comply with the regulation.
One other wild card is a legal challenge to the measure that asserts the SEC exceeded its authority in promulgating Reg BI and ignored a mandate from Congress in the Dodd-Frank financial reform law to formulate a uniform standard of conduct for brokers and advisers. That will be heard June 2 in the U.S. Court of Appeals for the 2nd Circuit.
As the advent of Reg BI approaches, it’s not clear what exactly will be different about how brokers deliver investment recommendations to clients — other than there will certainly be many more pages of disclosures about potential conflicts of interest.
So far, brokerages haven’t revealed much about operational changes.
In April, Merrill Lynch said it will level the pay its advisers receive for the sales of mutual funds and remove a small number of high-fee funds from its platform, among other steps.
Last fall, UBS indicated it is eliminating management fees on select separately managed accounts. Earlier this year, it decided to sell only a single share class of mutual funds.
During a recent call with reporters, UBS touted the two moves as setting itself apart when it comes to Reg BI reforms.
“That initiative is designed to remove the potential conflict of interest at the point of recommendation to the client,” Steve Mattus, head of advisory and planning products at UBS Global Wealth Management, said of the mutual fund change. “Other firms are not doing these things to the extent we’re doing them.”
The vast majority of the brokerage industry supported Reg BI during the rulemaking process. But most firms are staying silent on what Reg BI will mean on a practical level.
InvestmentNews reached out to several. Raymond James declined to comment. JPMorgan Chase and LPL Financial did not respond to requests for comment.
An Edward Jones spokesperson said the firm is enhancing client disclosures and adviser training. A Morgan Stanley spokesperson said the firm already is prepared to implement Reg BI as a result of its “efforts during DOL and since.”
There wasn’t much more illumination from Fidelity Investments. A spokesperson said the firm will disclose more information to clients around fees, obligations and potential conflicts of interest.
The fact that firms are setting their policies and procedures for Reg BI while working from home during the pandemic could contribute to the silence.
“It’s a little more siloed, and that may be why we’re not having a more robust public dialogue or debate about what firms should be doing,” said Kurt Wolfe, an attorney at Troutman Sanders.
One industry official said Reg BI is going to usher in significant changes.
Mark Quinn, director of regulatory affairs at Cetera Financial Group, said Reg BI “is a substantial raising of the bar over the old suitability standard. I’m not sure there is much daylight between fiduciary duty and Reg BI.”
For instance, he said Cetera would change how it manages account selection, putting more emphasis on the best choice for a client’s situation rather than just outlining the differences between brokerage and advisory accounts.
“We’re going to ask the client to affirmatively state this is the one I pick and why,” Quinn said.
But the full impact of Reg BI won’t be known until brokerages start to work under it.
“A lot of the changes related to Reg BI will be evolutionary,” Quinn said. “We know what we’re going to do on July 1, but that may not be what we’re doing on July 1, 2021.”
Cetera leveled broker compensation across variable annuities and illiquid alternative investments in 2016 and 2017 in preparation for the DOL rule.
“We did the heavy lifting on that already,” Quinn said.
The DOL rule legacy paved the way for Reg BI by helping firms prepare for the latter’s standard-of-care obligations, said Tim Slavin, senior vice president for retirement at Broadridge Financial Solutions.
“I’d say 80% of it was done and the rest of it was thought through,” Slavin said.
The DOL experience also is giving firms confidence about Reg BI.
“A lot of firms feel that post-DOL, they’re in pretty good shape to meet their general obligations mandated by Reg BI,” said Greg O’Gara, senior research analyst at Aite Group.
But some financial firms walked back the changes they had touted to comply with the DOL rule as soon as it was clear it would fall away during the Trump administration. That makes Roper wary of references to the DOL compliance process.
“I don’t know that we can put too much stock in that in terms of ensuring that we have strong investor protections in place,” she said.
There’s more silence surrounding Reg BI than the DOL rule because Reg BI puts relatively less emphasis on the cost of an investment recommendation, said Robert Lavigne, managing director at the Bates Group. Under Reg BI, a broker must consider cost among other factors.
“It’s not the race to the bottom that DOL was,” Lavigne said. “There are other factors that come into play. It doesn’t seem as if firms are feeling the pressure to overhaul their compensation scheme.”
The fact that Reg BI provides more flexibility around costs is why there’s not an avalanche of new investment products that conform to it, said Aron Szapiro, director of policy research at Morningstar Inc.
“We are not seeing new share classes being created en masse in response to Reg BI,” Szapiro said. “The rule is not prescriptive.”
The investment advice sector already is moving sharply toward lower costs, a direction to which Reg BI could contribute rather than spur.
“It’s a significant accelerator of the secular trend,” said Matt Radgowski, Morningstar head of adviser solutions.
There’s general agreement that one thing that will change in the broker-client relationship is that there will be much more disclosure.
It will start with the client-relationship summary of two to four pages that outline a firm’s fees, services and potential conflicts of interest. Most brokerages will add many more pages of disclosure to the so-called Form CRS.
Hank Sanchez, managing director at Bates Group, said the disclosure document will encourage investors to press brokers on their conflicts.
“The conversation-starter questions are prominent,” Sanchez said. “They’re really going to jump off the page.”
But other experts say Reg BI disclosures will fall on deaf ears.
Reg BI requires that brokers act in the best interests of their clients but it doesn’t define what that means. Much of the interpretation could be left to SEC enforcement.
“They’re going to determine which firms are compliant and which are noncompliant,” Brandon Reif, owner of Reif Law Group. “You’re going to see regulation by hindsight.”
Looking ahead, there’s disagreement over how meaningful Reg BI will be in reducing broker conflicts and changing how advice is delivered.
“Reg BI and Form CRS move us in the right direction,” O’Gara said. “It’s not the fiduciary standard many incumbents were looking for. However, I bet the SEC and [the Financial Industry Regulatory Authority Inc.] are going to enforce this. If brokers don’t do the right thing and eliminate sales practices that hurt investors, they’re going to pay a price.”
Kurt Schacht, managing director at the CFA Institute, is less hopeful.
“We think brokers will tout Reg BI as some new, big change in how customers are being treated when, in fact, it is still the sales relationship,” Schacht wrote in an email. “Customers will be deceived by that.”
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