On June 5, 2019, the SEC adopted new rules concerning the standards of conduct for both registered investment advisers (RIAs), such as Telemus, and broker-dealers. The goal behind the rules package is to minimize investor confusion and raise standards by which broker-dealers operate. But it’s worth exploring why these rules had to be implemented in the first place and why it means big changes for broker-dealers, but much less change for RIAs.
While both investment advisors and broker-dealers seemingly provide similar offerings in investing, one of the main differences between the two is that an RIA has an overarching fiduciary duty to offer services that align with the client’s best interest. This fiduciary obligation is ongoing and applies for the entire client relationship, whereas a broker-dealer is transaction-based and traditionally held to a suitability standard. The broker-dealer standard is limited both in time and scope (i.e., transaction-by-transaction) and only applies when a recommendation is made. Broker-dealers also often push their own proprietary products which can result in putting their interests ahead of their clients.
Don’t get me wrong. It’s not that their products are necessarily bad or that they’re intentionally misleading their clients, but a company typically prefers to sell its own products and realize the extra profit. Since the Department of Labor’s Fiduciary Rule was struck down by the U.S. Court of Appeals for the 5th Circuit, broker-dealers have had no regulatory obligation to put their client’s interests before their own.
The SEC’s rulemaking package is designed to address this.
Regulation Best Interest. RIAs have been operating under the legal guidelines of the fiduciary standard which is more comprehensive than the new best interest standard for broker-dealers. It is, indeed, the “gold standard.” Broker-dealers still aren’t required to advise clients at the fiduciary level, but they now must comply with an elevated “best interest” standard when they recommend an investment product to a retail client. It’s just when the recommendation is made though, so the obligation is limited both in time and scope. The difference between a broker-dealer and an RIA is that the RIA has an ongoing fiduciary duty to manage the client’s account(s), whereas the broker-dealer’s obligation is transaction-by-transaction.
Form CRS Relationship Summary. This is a new relationship summary form that broker-dealers and RIAs will have to provide to retail investors starting in July 2020. It will provide information about fees, costs, conflicts of interest, legal/disciplinary history and the required standard of conduct associated with the client relationship and services. RIAs already provide a firm brochure (i.e., Form ADV Parts 2A and 2B), so this new two page document will supplement those documents. Form CRS will provide clients with more information about the scope of the relationship with their RIA or broker-dealer so they will be more fully informed.
SEC Interpretation Regarding Standard of Conduct for Investment Advisers. This interpretation describes more fully the existing fiduciary standard of conduct that RIAs must abide by. The interpretation didn’t change the requirements applying to RIAs. Instead, it clarified an adviser’s fiduciary duty and reaffirmed the special relationship of trust and confidence an adviser has with its clients.
‘Solely Incidental’ interpretations. This part of the rulemaking package addresses the exclusion applying to broker-dealers under the Investment Advisers Act which allows them to avoid registering as investment advisers. Brokers may avoid registration if their advice is “solely incidental” to the conduct of their business as a broker-dealer and for which they do not receive “special compensation.” The rule interprets the “solely incidental” test broadly.
Is all of this a good thing or a bad thing? These changes are good in that they further clarify the obligation of registered investment advisers and broker-dealers relative to their clients, including the roles they play and their obligations. It benefits people who use broker-dealers because it raises the broker’s duty owned to their customers from a suitability standard to a best interest standard. This is still not at the fiduciary standard level that RIAs operate at, however. Advisers such as Telemus must continue to provide advice to their clients in accordance with their fiduciary obligations to their clients. This won’t change, and that’s a good thing!