SEC Chair Jay Clayton refuted criticism of the SEC's recently adopted rulemaking package designed to strengthen protections afforded retail investors on services provided by broker-dealers and investment advisers. The rulemaking package consists of (i) Regulation Best Interest ("Reg. BI"), (ii) the Form CRS Relationship Summary, (iii) an interpretation of investment advisers' fiduciary duty (the "Fiduciary Interpretation"), and (iv) an interpretation of the "solely incidental" prong of the broker-dealer exclusion under the Advisers Act.

In a speech in Boston, Mr. Clayton responded to seven claims that he believes are inaccurate, asserting that:

1. It is unrealistic to believe that it is possible to eliminate all conflicts of interest, and Reg. BI goes as far as is practicable in addressing broker-dealer conflicts of interest.

2. Reg. BI's principle-based approach is preferable to a more prescriptive approach to the definition of "best interest," which assumes that it would be possible to identify the "best" transaction for a particular investor.

3. The Fiduciary Interpretation applicable to investment advisers does not weaken the existing fiduciary duty but, rather, codifies existing SEC practices.

4. The Fiduciary Interpretation does require advisers to "avoid" conflicts.

5. The standards of conduct requirements under Reg. BI and the Fiduciary Interpretation cannot be met by disclosures alone, but require that firms act in the best interest of their customers.

6. Imposing an ongoing monitoring requirement on broker-dealers would not enhance Reg. BI and effectively would impose on them the duty to act as investment advisers.

7. The Form CRS Relationship Summary, along with online education resources, will provide material assistance to retail investors in understanding the duties they are owed by financial service providers.

Commentary / Steven Lofchie

When Regulation Best Interest was proposed, then-Commissioner Stein dissented from the proposal, saying it did not go as far as the DOL's Fiduciary Rule Proposal; and while Commissioner Jackson voted to allow the proposal to go forward, he also criticized it as not going far enough. This should have served as a warning to Chair Clayton than any regulation that he adopted short of an imitation of the DOL's Fiduciary Rule was going to be the target of substantial criticism. Chair Clayton proceeded on the basis that there was some middle ground of compromise that would satisfy detractors. That was simply not going to be the case.

Now, in many respects, we have ended up with the worst of all possible situations: (i) the Reg. BI adopting release fails to make any strong intellectual argument for why it is not reasonable to expect that broker-dealers can be fiduciaries to their clients; (ii) Reg. BI fails to make any distinction between sophisticated and unsophisticated natural person clients (treating Warren Buffett no different from a high school dropout); (iii) Reg. BI imposes significant new obligations on broker-dealers that very well may reduce the willingness of broker-dealers to provide "full-service" brokerage to retail investors and instead result in retail investors seeking any level of advice to potentially pay a much higher charge to an investment adviser; (iv) Reg. BI fails to satisfy any of the critics who wanted a fiduciary obligation imposed on broker-dealers; and (v) states are adopting their own "suitability" rules - urged on by Commissioner Jackson - thereby moving U.S. securities regulation away from a unitary system of regulation to a fractured Brexit system. See generally Cadwalader memorandum: Choose One - Best Interest or Full Service (Apr. 26, 2018); see also SEC Adopts Regulation Best Interest (June 6, 2019).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.