Roosevelt Institute | Cornell University

Regulation Best Interest Might Not be in Your Best Interest

By Abigail CundiffPublished December 4, 2019

The new SEC Regulation Best Interest endangers investors by blurring the distinction between a broker-dealer and a registered investment advisor.

When you ask for advice, you generally expect it to be given with your best interest in mind.  Similarly, when a regulation titled “Regulation Best Interest” is rolled out by the U.S. Securities and Exchange Commission (SEC), a financial market regulator, you would expect such measures to act in your, the investor’s, best interest. The recently passed Regulation Best Interest (Reg BI), however, defies these logical expectations and, in doing so, endangers investors.


Reg BI was adopted by the SEC on June 5, 2019 and goes into effect on June 30, 2020. It’s intended to enhance the standard of conduct exercised by broker-dealers by requiring them to go beyond existing suitability requirements. Reg BI requires brokers-dealers to not place their own interests ahead of their clients’. A number of new requirements have been introduced to meet this standard; Broker-dealers would have to disclose material facts about their recommendations and their capacity as a broker-dealer, exercise reasonable diligence and care when making recommendations to retail customers, and establish and enforce policies and procedures to comply with the regulation. In many ways it resembles the dead Department of Labor (DOL) Fiduciary rule which would have required broker-dealers working with retirement accounts to act in the best interest of their clients, place those interests above their own and disclose all conflicts of interest, fees, and commission for retirement planning. Reg BI is, however, a poor substitute. In theory, though, any enhanced suitability obligations for broker dealers should protect investors by improving the transparency of the advice they receive, but Reg BI falls short of establishing any new standard and is more a trap for retail customers than a protection.


To understand why it’s a trap, it’s important to understand the status quo. There is a distinction between broker-dealers and registered investment advisors (RIAs). With regards to payment schedules, broker-dealers are paid on commission to sell financial products to retail customers. RIAs, on the other hand, are paid fees to provide financial advice. Broker-dealers are accessible to a greater number individuals because commission payments are cheaper than a fee. A second difference lies in the care these two parties take with regards to suitability. Broker-dealers are not registered to provide advice but when they recommend investments, they must be considered “suitable,” a quality that is determined by various characteristics of the specific retail investor, recommendations. RIAs, however, are held to fiduciary duty, which means they are legally obligated to put their customers’ interests before their own and avoid conflicts of interest.


For the most part, Reg BI simply codifies the existing situation. Many worry that the rule never explicitly defines best interest. They also worry that disclosing conflict of interest is insufficient and the method of disclosure may be buried in the fine print and further confuse investors. In codifying the status quo and applying what Barbara Roper of the Consumer Federation of America says is a weak interpretation of the fiduciary standard, Reg BI allows broker-dealers to market themselves as something more akin to an RIA. Reg BI waters down the meaning of best interest since it is no longer supported by fiduciary duty and challenges the important distinction between RIAs and broker-dealers. This is why the SEC faces, not one, but two lawsuits.


These two lawsuits draw attention to the problem faced by consumers but also to that of the state and the RIAs. The first lawsuit was filed on September 9 by attorneys general arguing on behalf of various states. They claim that the confusion faced by investors poses a serious problem for the state’s financial wellbeing. In trusting the potentially conflicted advice from a broker as truth, an investor can lose money quickly. For example, one Manhattan middle-school art teacher reported, her broker told her he was selling 403(b)’s to which she signed on. This broker transferred her retirement savings from a guaranteed investment that paid 7 percent into an annuity with a 2 percent annual fee. While this individual was able to reclaim her initial position having only lost a few thousand dollars, some people are not all that lucky. The attorneys general claim that the depletion of retirement distributions would cause the state to lose taxable revenue and, if the retirement savings of some constituents are seriously depleted, more individuals would end up in welfare and pose a burden to the state.


The second lawsuit was filed September 10th by XY Planning Network, LLC and its member firm Ford Financial Solutions, LLC. Micheal Kitces, the main plaintiff on this case, claims the lawsuit is on behalf of the interests of RIAs and the protection of consumers. RIAs would be seriously disadvantaged since they charge higher fees than their broker-dealer counterparts if broker-dealers can also proclaim to give advice in the best interest of their clients. Kitces two main challenges to Reg BI are 1) disclosures are insufficient and 2) dual registrants can switch back and forth between being a broker-dealer and being and RIA without the client knowing all while under the guise of placing the clients best interest ahead of their own. Kitces states that the SEC can either follow the Dodd Frank Act of 2010 and require broker-dealers to adhere to the same fiduciary standards as RIAs or to the Investment Act of 1940 that allows only  RIAs to give financial advice. Kitces favors the latter and I concur. Separation makes loyalties black and white and eliminates any opportunity to misled investors. 


In redrawing the boundary between broker-dealer and RIA, the SEC fails in its efforts to protect investors. Greater access to a financial advisor is important and Reg BI offers a glimpse of financial advice given on commission, but it is executed poorly and investors deserve a better-than-nothing piece of legislation. Muddling distinctions that define loyalties and watering down the definition of best interest is a dangerous road to go down and not one that should be pursued in this manner. Perhaps what is in our best interest is to stick to pre-existing pieces of legislation by following either the Investment Act of 1940 or Dodd Frank. Until everything settles down and the SEC answers to its many complaints, though, the best piece of advice an investor can have might be to never trust a claim of best interest unless it’s written down on paper.

Works Cited

Works Cited