SEC tells advisors to rein in conflicts of interest under Reg BI

For two years, wealth advisors have demanded answers from the SEC about how it intends to enforce Regulation Best Interest, the 2020 rule that sets a minimum standard of retail client care in financial advice. They are unlikely to be cheered by the Wall Street's regulator's latest guidance. 

The SEC issued a red alert on Aug. 3 to brokerages and registered investment advisors indicating that it intends to take a tougher stance on the conflicts of interest that plague the retail investing industry. The guidance, part of the SEC's campaign to enforce Reg BI, offers the most specific clues yet to where the regulator will aim its audits and enforcement actions against misbehaving brokers and advisors. Those targets include aspects of financial advisor compensation, payment agreements and certain longtime industry practices it says aren't in a client's best interest. The guidance also signals a more active approach by the SEC after a 2018 court decision struck down a previous regulation with stronger client protections. 

Reg BI requires brokerages to recommend investments and transactions that are in a client's best interest. The previous, lower standard required investments that were merely "suitable." But Reg BI still has weaknesses: While brokers have to disclose and mitigate conflicts of interest, they don't have to avoid all of them. By contrast, the fiduciary standard governing RIAs requires them to place a client's interest above their own at all times and to eliminate many more of those conflicts. The SEC brought its first enforcement case under Reg BI in June and hinted last month that more are on the way.

Under Reg BI and the fiduciary standard for RIAs, a conflict is anything "that might incline a broker-dealer or investment adviser — consciously or unconsciously — to make a recommendation or render advice that is not disinterested," according to the bulletin. "The staff believes that identifying and addressing conflicts should not be merely a 'check-the-box' exercise, but a robust, ongoing process that is tailored to each conflict."

Representatives for the Securities Industry and Financial Markets Association, which represents the largest brokerages, banks and asset managers, didn't respond to a request for comment on the bulletin. Representatives for the Financial Services Institute, which advocates for independent wealth managers, declined to discuss the bulletin.

"We would need time to thoroughly review this bulletin before providing comment, but, overall, we believe that the successful implementation of Regulation Best Interest is the best way to protect investors, including from conflicts of interests, and current enforcement efforts demonstrate that Regulation Best Interest is working," General Counsel David Bellaire said in a statement.

Christine Lazaro, Director of the Securities Arbitration Clinic at the St. John's University School of Law, said that the new bulletin shows that the SEC has seen research from its state-level counterparts suggesting that wealth managers are violating Reg BI by placing their own profits above their clients' interests.

The guidance should come as no surprise to any large wealth managers seeking to comply with Reg BI and its predecessor, Lazaro said. The Department of Labor's 2016 Fiduciary Rule sought to bring nearly all of the industry in line with the standards of RIAs, but an appeals court vacated that regulation two years later. Lazaro said that the bulletin uses much of the same language as the preamble to Reg BI about conflicts of interest.

The bulletin "reinforced that disclosure is absolutely not going to be sufficient mitigation," Lazaro said, noting that it makes clear that comparisons to industry norms won't meet the bar, either. "That I think is incredibly significant, in terms of making clear that the expectations are to actually mitigate conflicts," she added.

For a summary of the key takeaways from the lengthy SEC "staff bulletin" about conflicts of interest, scroll down the slideshow. To see a list of the SEC's examination priorities this year, click here. And, for a list of nine ways to evaluate client risk, follow this link.