Understanding the SEC's New Best Interest Regulation and What's Ahead

  • Originally published June 27, 2019 , last updated July 10, 2019
Understanding the SEC's New Best Interest Regulation and What's Ahead

Advisors and brokers making investment recommendations will soon face new federal disclosure and compliance requirements to act in their clients’ best interest, but insurance-only agents might also face new standards soon, too.

The U.S. Securities and Exchange Commission on June 5 adopted Regulation Best Interest, which calls for brokers to act in the best interest of their clients when making investment recommendations. The rule goes into effect June 30, 2020. 

The rule does not apply to insurance-only agents who don’t sell securities. However, some state governments and the National Association of Insurance Commissioners (NAIC) are working on their own standards that would apply to insurance agents.

“Registered representatives and investment advisor representatives will need to see how their broker-dealers and RIAs interpret the rule,” said Bill Kauffman, Vice President of Financial Solutions at Senior Market Sales® (SMS). “At SMS, we’re monitoring which states are discussing or enacting guidelines that will impact our insurance-only agents, as well as what the NAIC is considering.”  

Filling a Regulatory Void

The SEC regulation comes after the creation and ultimate demise of the hotly contested fiduciary rule, an Obama-era regulation which would have required brokers to act as fiduciaries and in the best interests of their clients in retirement accounts. In June 2018, a U.S. appeals court confirmed a decision to strike down the Department of Labor’s fiduciary rule, effectively killing it and providing an opportunity for the SEC to fill the regulatory void.

Currently, brokers and insurance agents are held to a suitability standard — which says if a recommended investment meets the objectives of the client, the product is considered “appropriate” — while registered investment advisors (RIAs) are held to a “fiduciary” standard, meaning their advice must be in the clients’ “best interest.” The DOL fiduciary rule would have expanded the accountability of all financial advisors offering retirement account advice to the fiduciary standard. The SEC’s Regulation Best Interest attempts to improve investor protections beyond suitability but not to the extent of the fiduciary rule.

The Four ‘Obligations’ of Regulation Best Interest

The law firm Drinker Biddle — whose Best Interest Compliance Team assists with the evolving and overlapping federal and state regulations related to the standard of care — analyzed the more than 1,300-page regulation, explaining that it is made up of four “obligations”:

  • Disclosure Obligation: Broker-dealers must disclose material facts about the relationship and recommendations, including specific disclosures about the capacity in which the broker is acting, fees, the type and scope of services provided, conflicts, limitations on services and products, and whether the broker-dealer provides monitoring services.
  • Care Obligation: A broker-dealer must exercise reasonable diligence, care, and skill when making a recommendation to a retail customer. The broker-dealer must understand potential risks, rewards, and costs associated with the recommendation. The broker-dealer must then consider these factors in light of the retail customer’s investment profile and make a recommendation in the retail customer’s best interest.
  • Conflict-of-Interest Obligation:  While the current suitability standard only requires advisors to consider conflicts of interest when offering products, Regulation Best Interest requires them to identify, disclose and mitigate conflicts of interest.
  • Compliance Obligation: Broker-dealers must establish, maintain, and enforce policies and procedures reasonably designed to achieve compliance with Regulation Best Interest as a whole (by June 30, 2020).

Brokers and Insurance-Only Agents: Stop Using ‘Advisor’

As part of the disclosure obligation, insurance agents and brokers who are not dually registered as investment advisors cannot use the term “advisor” or “adviser” in their title.

Brokers increasingly have marketed themselves as financial advisors, partly due to regulatory efforts that have highlighted that they don’t have to act as fiduciaries. Regulation Best Interest attempts to clarify what type of relationship the client has with the professional. In the more than 10 pages of the regulation dedicated to the topic of title reform, it states: “We believe that in most cases, broker-dealers and their financial professionals cannot comply with the capacity disclosure requirement by disclosing that they are a broker-dealer while calling themselves an "adviser" or "advisor.”

The Future for Insurance-Only Agents

While Regulation Best Interest otherwise does not apply to insurance agents not selling securities, the legislation being discussed by states and the NAIC could define some standard-of-care rules that would impact insurance-only agents, whether the standards are called fiduciary rules or best interest rules. (Through the NAIC, state insurance regulators establish standards and best practices and coordinate their regulatory oversight.) If the NAIC does not first come up with the standard before individual states start enacting their own, a regulatory patchwork could result, with some brokers held to a fiduciary standard and others not.

SEC Chairman Jay Clayton, however, has warned against a regulatory patchwork in state regulations that “will increase costs and make enforcement more difficult.”

SMS’ Kauffman said that SMS does not oppose state- or NAIC-defined standards as long as they are not overly restrictive and do not interfere with the delivery of services. For example, an insurance-only producer should not be required to take a Series 65 exam to become a fiduciary, he said.

“Every industry has its bad apples, but we believe that most insurance-only agents and advisors are already operating in the best interest of their clients,” Kauffman said. “We understand the need for certain guidelines, but it remains to be seen what the individual states and NAIC might come up with.”

What would be ideal, Kauffman said, would be a beefed-up suitability standard that enhances the services that the different financial services and insurance professionals provide, not strict regulations that would discourage professionals from the industry. Cumbersome regulations that make compliance costly to producers could have the effect of limiting retirement services to only the wealthy consumer.

“Now is not the time to be chasing professionals away from the insurance business,” he said. “We’re in the middle of the baby boomers retiring. Consumers need multiple choices, multiple solutions. They need the help of insurance agents, broker-dealers, IARs — all of today’s retirement planning professionals.”

Business As Usual for SMS’ RIA

For SMS’ RIA, Sequent Planning, it’s business as usual, since its IARs operate as fiduciaries already, said Rick Reed, Sequent Planning’s Chief Compliance Officer.

In the coming year, expect to see more clarification from regulators as they interpret Regulation Best Interest, Reed said. He and others in the industry say you may also see a shift as broker-dealers may tire of the multiple layers of interpretation — by the SEC, FINRA, state regulators and the NAIC.

“(Regulation Best Interest) is going to drive more people to the advisory world, because of the clarity and simplicity of one rule-making body — in this case, the SEC,” he said.