Regulation BI Narrows Gap Between Brokers, Advisors

New Market Conduct Rules Arriving

Consumer confusion concerning the fiduciary responsibilities between financial advisors and brokers seems likely to continue with a new Securities Exchange Commission rule narrowing the gap between both groups’ market conduct duties.

For decades, Registered Investment Advisors (RIAs) have been classified as fiduciaries, requiring them to act in the best interests of their clients – regardless of their own interests or those of their firms. Broker-dealers have long been held to what the SEC terms a “quasi-fiduciary” standard to make suitable recommendations to clients. An earlier effort by the U.S. Department of Labor to hold brokers to the same fiduciary standards as investment advisors was struck down in 2018 by a federal appeals court.

The SEC is addressing that issue with Regulation Best Interest (Reg BI), effective June 30, 2020. Reg BI requires brokers to act in the “best interest” of their clients. While the new rules do not hold brokers to the fiduciary standard, Reg BI sets the bar higher than the previous “suitability” standard.

The new rules do not change the duties of investment advisors (although the SEC has updated some details of the RIA fiduciary obligations). However, Reg BI does introduce additional disclosure requirements for RIAs as well as broker-dealers. Both types of financial professionals must provide clients with the newly-created Form CRS (Customer/Client Relationship Summary). The document discloses information such as fees, costs, compensation, conflicts of interest, and standards of conduct.

Reg BI has drawn criticism from consumer advocates who maintain establishing another conduct standard will increase confusion among consumers who generally already do not understand the differences from an investment advisor, a broker-dealer, and a dual registered advisor. Seven states plus the District of Columbia have challenged the standard in federal court, maintaining all parties should be held to the same fiduciary standard. SEC Chairman Jay Clayton defended creating different standards for different roles, saying that individual investors have specific needs that must be addressed separately.

Distinguishing between brokers and investment advisors is likely to continue challenging consumers who often assume all roles carry the same client care responsibilities. Several investment advisors told Advisors Magazine there are some basic ways to tell the difference between those types of advisors.

Two basic characteristics distinguish an investment fiduciary, a broker, or a dual registered advisor, according to Reggie Ford, CPA, founder and president of Rosecrete Wealth Management in Nashville, Tennessee. Those factors are the advisor’s fee structure, and the type of registrations and licenses they hold.

“Investment fiduciaries work on a fee-only or fee-based model,” Ford said. “The fee might be a flat or hourly rate; on a per-service basis; or on a percentage of assets under management. They are registered as an RIA, and typically hold a Series 63/65 or Series 66 designation.”

Brokers work on a commission based model that normally pays for each transaction related to sales of investments or products, he continued. Brokers (including stockbrokers, insurance agents, and registered representatives) typically hold Series 6 or Series 7 designations.

Dual registered advisors are registered as both investment fiduciaries and non-fiduciaries, Ford said. They may receive compensation from either fee-based or commission-based models, and may hold a combination of licenses and/or registrations.

“Legally, investment fiduciaries are held to an ethical duty of doing what is in their client’s best interest, while brokers are only held to a responsibility of making suitable recommendations for a client,” Ford noted.

However, the SEC’s recent approval of Reg BI is changing that distinction.

“Laws are being enforced on broker-dealers and their associated persons, whether investment fiduciaries or not, to make recommendations that are in clients’ best interest and provide additional disclosures to better inform clients,” Ford said. “In response, many brokers are shifting to the fiduciary standard as a better way to adhere to the laws and regulations with less gray area.” Brokers typically focus on investment activities and transactions. However, for financial advisors, investments are only one part of their business. Advisors work with clients to identify their goals and plan strategies that address all aspects of their financial life, such as creating a budget, financing college, or planning for long-term care. Charles Massimo, CEO and founder of CJM Wealth Management in Deer Park, New York, said the best way to distin – not at what they call themselves.

“We always focus on the goal – not on beating an index or finding the next Google,” Massimo said. “Having a deep understanding of a client’s needs well before you invest one dollar is the first part of mitigating risk, regardless of market or economic conditions.”

He continued, “Our advice is consistent. We focus on the goal and the behavior of the investors themselves, rather than reacting to the directions of the market. We keep them engaged by communicating that message even more during volatile times through

blogs, webinars, and one-on-one calls. This may sound simplistic, but it’s very effective versus those who react almost weekly or daily to changes in the markets.”

Advisors also need to be transparent about the structure of their business, according to Wayne Wagner Jr., ChFC, president of Vizionary Wealth Management in Wilmington, Delaware. He said the compensation structure of the client advisor relationship should not be the sole measurement of whether an advisor is acting in the client’s best interest.

“We see a variety of areas where advisors present themselves as ‘fiduciary only’, and then use an investment product that actually performs worse for the client (net of expenses) relative to the exact same product on a brokerage platform that pays a commission,” Wagner said. “The advisor needs to be open and communicate the rationale for using the product type, the specific vehicle, and why it may be offered on one platform versus the other. Too often I see people waving their ‘fiduciary flag’ who are not acting in the actual best interest of the client.”

While the meaning of the term “fiduciary” continues to draw broad discussion, he added, some advisors call themselves “fiduciary only” mainly to avoid FINRA compliance burdens. Reviewing their portfolio construction may uncover layers of fees, conflicts of interest, or commissions paid on some products.

“How I am compensated shouldn’t determine whether I am acting in my client’s best interest,” Wagner added. “I should always, every day, in every situation, put my client’s needs first, and be able to articulate why a recommended course of action is in the client’s interest first. Ours seems to be the only industry where compensation somehow measures whether the advisor is acting correctly.”