SEC Commissioner Kara Stein, the lone dissenter in the regulator’s 4-1 vote Wednesday to move ahead with the 90-day public comment period for its Regulation Best Interest package, spent considerable time picking apart the proposal – which she believes generally “protects the broker-dealer, not the customer” – during the watchdog’s open meeting last week.

The proposed three-part package establishes a best interest standard of conduct for broker-dealers, interprets the fiduciary standard for investment advisors, and creates a new Customer Relationship Summary form aimed at clearly stating to clients if they are dealing with a broker-dealer or an investment advisor.

Instead of holding broker-dealer advisors to a higher standard, the proposal “squanders the opportunity to act in the best interest of investors,” according to Stein, a Democrat.

Stein’s first point of contention – shared by SEC Commissioners Robert Jackson, Hester Peirce, and Michael Piwowar — is the lack of clarity on exactly what “best interest” means.

“Despite repeated requests to define what best interest means in the rule text, it was decided that there was no need to define it,” Stein said.

Since the proposal doesn’t define best interest, the name of the rule is “confusing” and even “misleading” because investors might assume their broker-dealers are indeed working in their best interest, she said. “Unfortunately, that is not the case.”

Stein believes the proposal merely reaffirms that broker-dealers must meet the suitability obligations already required by Finra.

The requirements for broker-dealers to discharge their best interest duty are merely in line with suitability standards, she said. As put forth in the SEC’s Regulation Best Interest package, those requirements are:

  • Disclosure obligation: Disclose to the retail customer the key facts about the relationship, including material conflicts of interest.
  • Care obligation: Exercise reasonable diligence, care, skill and prudence, to understand the product; have a reasonable basis to believe the product is in the retail customer’s best interest; and have a reasonable basis to believe a series of transactions is in the retail customer’s best interest.
  • Conflict of interest obligation: Establish, maintain and enforce policies and procedures reasonably designed to identify – and then, at a minimum, to disclose and mitigate, or eliminate – material conflicts of interest arising from financial incentives. Other material conflicts of interest must be at least disclosed.

“Does this proposal require financial professionals to put their customers’ interests first, and fully and fairly disclose any conflicting interests? No. Does this proposal require all financial professionals who make investment recommendations related to retail customers to do so as fiduciaries? No. Does this proposal require financial professionals to provide retail customers with the best available options? No,” Stein said.

To truly hold broker-dealers to a higher standard, Stein said the proposal could have required broker-dealers to eliminate or mitigate conflicts of interest, instead of requiring them to have reasonably designed policies and procedures. She said the proposal could have also required broker-dealers to provide “full and fair” disclosure, instead of just “reasonable” disclosure.

“We could have expected more from financial professionals who provide retail investors with investment advice,” she said. “If they are going to give advice in the first place, broker-dealers should truly act in the best interest of their customers given the impact this advice can have on retail investors’ financial well-being.”

Commenting on the proposed Customer Relationship Summary (CRS) form, Stein said it is “too generic and too legalistic,” making her doubt that retail investors would even bother to read it.

The CRS is a proposed requirement for investment advisors and broker-dealers (and associated persons of broker-dealers) to make clear to investors whether they are dealing with an investment advisor or a broker-dealer.

This standardized disclosure form – to be a maximum of four pages in length – requires an explanation of the principal types of services offered; the legal standards of conduct that apply to the investment advisor or the broker-dealer (whichever relationship applies); the fees a client might pay; and certain conflicts of interest that may exist.

Stein said corporate disclosure requirements are typically filled with “stilted boiler-plate jargon” that works in favor of the companies.

Stein said a sample CRS she reviewed is confusing and doesn’t give retail investors a meaningful explanation of how broker-dealers are acting in their best interests.

The same CRS contained these sentences, she noted: “We must act in your best interest and not place our interests ahead of yours when we recommend an investment or an investment strategy involving securities. When we provide any service to you, we must treat you fairly and comply with a number of specific obligations. Unless we agree otherwise, we are not required to monitor your portfolio or investments on an ongoing basis.”

Stein proposed that the disclosure in the CRS should go further by providing the retail investor with a meaningful explanation of what best interest means to him/her; how much the retail investor would pay per year for an advisory account or for a brokerage account; what will be the retail investor’s investment return net of fees; and what could impact those fees.

“Without these types of disclosures, we will likely run the risk that a retail investor simply glances at these words and shoves them in the back of the file cabinet, or worse, the recycling bin, along with the rest of the boilerplate disclosure he or she receives,” she said.

Stein pointed out that the proposal is placing the onus on the retail investor to understand the broker-dealer’s best interest obligations. She noted that at the end of the CRS is a list of “Key Questions to Ask,” which are meant to encourage retail investors to have conversations with their financial professionals about how the firm’s services, fees, conflicts and disciplinary events affect them.

“We are asking a retail investor to flip through four pages of boilerplate text, read through a series of questions, and then take the initiative to engage in a conversation with his or her financial professional about matters with which he or she may not be familiar,” she lamented.

Stein said that when the choice is whether to defer to financial professionals’ historical practices that have caused known harm or to give investors better disclosure and better advice, the SEC should err on the side of the retail investor.

“It is the financial professionals who have the information and the ability to fix the problem – not their customers.” She said. “Thus, when there is a question of where the burden of uncertainty should rest, it should rest with the more informed party – the financial professional.”

Article published by Financial Advisor IQ April 23 2018

Written by Rita Raagas De Ramos