Did the SEC "best interest" Regulation goes far enough? – JD Supra | Omd Cialis

The US Securities and Exchange Commission (SEC) has passed a new standard called Regulation Best Interest (Reg BI).[1] this shifts the focus primarily to protecting customers. While the regulation may prioritize certain customers, it leaves some key areas vulnerable.

What is the best interest of SEC regulation?

Reg BI was an amendment to the Securities Exchange Act of 1934 in 2019 to ensure broker-dealers were acting in the “best interests” of their retail clients when recommending that their clients buy, trade or otherwise take any action in securities.[2]

The stated goal of the SEC’s final rule on Reg BI is twofold: (i) to improve the obligations that apply to agent-client relationships when a recommendation is made, and (ii) to reduce the potential harm to clients who conflicts of interest may affect this recommendation.[3] Ultimately, Reg BI seeks to complement broker-dealer duties by building on principles inherent in the existing fiduciary duty of care and loyalty of financial advisors but not historically required of broker-dealers.[4]

These new obligations should not place a broker-dealer’s interests, financial or otherwise, ahead of the interests of his clients.[5]

Four Broker-Dealer Obligations under Reg BI

According to Reg BI, a broker-dealer has four specific duties that must be met:[6]

1. Duty of Disclosure

Prior to or at the time of the recommendation, the broker-dealer must write to the client and fully and fairly disclose to him all material facts relating to the scope and terms of his business relationship and any conflicts of interest that may apply to the recommendation.

2. Duty of Care

The broker-dealer must use reasonable care, diligence and skill in making his recommendation. It does this by understanding the potential risks, benefits and costs of the referral and having a reasonable basis for believing that the transaction is in the best interests of the client.

3. Commitment to Conflicts of Interest

The broker-dealer must maintain written policies and procedures that identify and disclose or eliminate any conflicts of interest, mitigate those conflicts that create an incentive to put the interests of the broker-dealer first, and disclose any material limitations on securities or investment strategies .

4. Commitment to Compliance

To reinforce the previous three obligations, the broker-dealer must establish, maintain and enforce written policies to comply with all facets of Reg BI. The broker-dealer entity has the flexibility of how best to design a compliance program that meets Reg BI’s goals and requirements.

As further evidence of the SEC’s commitment to implementing this customer-first change, the Municipal Securities Rulemaking Board (MSRB) was cleared to align its rules with Reg BI, which subsequently happened. The MSRB changes apply to situations not already covered by Reg BI.[7] This will address potential avenues for misconduct in both the corporate and municipal securities areas.

Possible protection issues due to Reg BI

There are conflicting opinions about Reg BI and its effectiveness in the market. While this new system emphasizes the needs of retail customers, concerns remain about the protection afforded by the regulation.

Lack of fiduciary duty for most brokers

Brokers, who are not acting as financial advisors with greater responsibilities to clients, must comply with the responsibilities outlined above.[8]

While these obligations are useful, the language in Reg BI does not create the stricter fiduciary duty for brokers required of investment advisers.[9] This lack of fiduciary duty leaves clients vulnerable to fraudulent practices by brokers who act as fiduciaries and can gain clients’ trust, while the (fine print) written documentation highlights that the broker-dealer is not acting as an investment advisor to the client doing so do should seek professional advice instead.[10] The responsibility then remains with sometimes inexperienced clients to determine whether they are making appropriate financial decisions.[11]

EU consumer protection

Consumer protection initiatives are not unique to the United States.

In particular, on April 11, 2018, the European Commission passed the so-called New Deal for consumers.[12] Once adopted, two EU instruments were implemented: (1) The EU Consumer Protection Enforcement and Modernization Directive (2019); and (2) The Representative Actions Policy (2020).[13] While these initiatives are broad in scope, they address issues such as online marketplace transparency, which have not been done in the US, and the implementation of tougher penalties for cross-border violators.[14]

While the focus is not so directly on the banking system alone, the move toward greater transparency for consumer protection is an international concern.[15]

crypto concerns

No US regulatory requirements

Until recently, the cryptocurrency industry continued to grow exponentially, making regulators concerned about what the future holds for banking, digital assets, and consumer protection. Benefits of anonymity and lack of security enable dark web transactions and other illicit crypto activities.[16]

Part of cryptocurrency’s initial appeal to crypto companies and crypto asset sellers was the lack of regulation surrounding virtual platforms. While this independence is one of the benefits of crypto, the lack of regulation poses a major risk for customers and general investors, as illustrated by the recent turmoil in the cryptocurrency market.

Possible SEC oversight

As technology has advanced, so have the issues related to regulation.

Currently, the SEC is struggling to fill the regulatory loopholes in the banking system created by the proliferation of cryptocurrencies. As a result, the SEC has begun investigating the possibility of regulatory oversight of the cryptocurrency. Currently, the test for determining whether something constitutes a security requires meeting the following elements: (1) investing money, (2) in a common enterprise, (3) having a reasonable expectation of profit, and (4) being originated from the efforts of others.[17]

Ideally, the SEC would apply these elements to cryptocurrencies so that stricter standards such as Reg BI could be enforced.[18] As a result, retail clients choosing to invest in this form of currency would be protected just as vocally as investors in more “traditional” currencies.

EU regulation

Other jurisdictions are also struggling with growing pains related to the crypto boom. Currently, the European Union requires all parties involved in a crypto transaction to be disclosed to the consumer.[19]

The European Union has also recently made efforts to promote consumer protection through its Consumer Policy Strategy for 2020, known as the New Consumer Agenda.[20] After examining whether additional legislation is needed, the European Commission has initiated a so-called fitness check of EU consumer law on digital fairness.[21] This program addresses the effectiveness of consumer protection and consumer vulnerabilities, targeting the digital space.[22]

Conclusion

The existence of Reg BI illustrates two important points.

First, it demonstrates the regulatory direction in which the financial industry is moving. Retail clients are increasingly viewed as more than just a ready source of reliable profits for a broker-dealer without the necessary protection. This came after the Consumer Financial Protection Bureau was created, sparked by the Great Recession, to put the customer above everything else. Now the interests of the client-investor must come first – at least on paper.

Herein lies the second and equally important lesson of Reg BI: it is not enough.

Which means putting the “best interests” of clients ahead of the agent’s financial and personal interests is a potentially malleable concept. Furthermore, it does not go far enough to protect vulnerable customers in markets that are less regulated overall, or even non-retail customers who are less experienced in understanding financial products or cannot afford truly independent financial and legal help.

New and complex innovations in the financial markets require new and complex solutions. It remains an open question whether Reg BI will fill the moment, or if something else will emerge to fill or complement this urgent need.

Additional research and writing by Clayton Spivey, a 2022 Summer Associate in ArentFox Schiff’s Boston office and a law student at Boston College Law School, and Kimia Pourshadi, a 2022 Summer Associate in ArentFox Schiff’s Boston office and a law student at Boston College Law School.


[1] 17 CFR §240.15l-1 (2019).

[2] See regulation in the best interestUS Securities and Exchange Commission (September 23, 2019), https://www.sec.gov/info/smallbus/secg/regulation-best-interest (“SEC Reg BI Summary”).

[3] See Regulation Best Interest: The Broker-Dealer Standard of ConductSecurities and Exchange Commission (nd), https://www.sec.gov/rules/final/2019/34-86031.pdf.

[4] ID at 72; see also the client alertdated July 22, 2021, entitled “LIBOR Transition: (Bet You Didn’t Know) Duties of Municipal Advisors and Insurers.”

[5] See SEC Rules BI Summary.

[6] ID.

[7] MSRB harmonizes rules with regulatory best interest requirementsMunicipal Securities Rulemaking Board (June 26, 2020), https://www.msrb.org/Rules-and-Interpretations/MSRB-Rules/General/~/media/DC84329EC1A14A0B9A1BA1C116A24CB9.ashx.

[8] Kelly Anne Smith, What Best Interest Regulation Means for Your Financial Adviser Forbes Advisor (March 5, 2021), https://www.forbes.com/advisor/investing/financial-advisor/regulation-best-interest/.

[9] ID.

[10] See I would. (In selecting the financial advisor with whom to work, clients should conduct their own due diligence by reviewing their financial advisor’s credentials on the SEC’s Investment Advisor Disclosure website and also reading the Client Relationship Summary in its entirety, albeit again in the proverbial fine print.)

[11] ID.

[12] review of EU consumer law, European Commission (last accessed on July 25, 2022), https://ec.europa.eu/info/law/law-topic/consumer-protection-law/review-eu-consumer-law_en (“Review of EU Consumer Law” ).

[13] ID.

[14] New consumer rights: What benefits do I get European Commission (May 2022), factsheet_on_benefit_consumers_en.pdf (europa.eu).

[15] See ID.

[16] ID.

[17] paul kim, The Howey Test: A set of rules for determining whether an investment is a security Insider Personal Finance (May 31, 2022), https://www.businessinsider.com/personal-finance/howey-test.

[18] ID.; see also Kate Rooney, Federal Judge Says SEC Rules Apply to Initial Coin Offering, CNBC (September 11, 2018) Federal Judge Says SEC Rules Apply to Initial Coin Offering (cnbc.com).

[19] Helen Femi Williams, EU pushes hard for crypto regulation, Fintech Nexus News (04/29/2022), https://news.fintechnexus.com/the-eus-regulatory-push-for-crypto/.

[20] See Review of EU consumer law.

[21] ID.

[22] ID.

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