North American Securities Administrators Association ("NASAA") President Michael Pieciak offered recommendations on how the SEC can improve Regulation Best Interest ("Regulation BI") to benefit investors.

In a written statement to the U.S. House of Representatives Committee on Financial Services, Mr. Pieciak said that it is necessary to raise the "standard of care" applicable to investment professionals to "reflect the evolution of how financial advice is delivered to customers." The standard of care, according to Mr. Pieciak, cannot be a "conflicts disclosure regime," but must be one where the provider of advice acts in the best interests of the investor.

NASAA recommended that the SEC:

  • define the "best interest" standard;
  • apply this standard generally to all investors, with limited exceptions; and
  • include "cost" as a factor that must be assessed when making recommendations.

Mr. Pieciak noted that NASAA's primary concern involves the SEC's interpretive guidance in the Regulation BI proposing release. He said that the guidance in the proposing release sends the wrong message to the brokerage industry with respect to how the rule should be read and how to change industry practices to better serve investors' interests. As to how Regulation BI can be clarified, Mr. Pieciak stated that:

  • the adopting release should specify that sales contests are not consistent with the standard;
  • revenue-sharing arrangements - if not prohibited - between brokers and product manufacturers must be carefully examined for compliance with the final rule;
  • when allocating investment opportunities, broker-dealers must not be able to give certain customers preferential treatment;
  • NASAA disagrees that a broker-dealer could meet its "best interest" obligations by "recommending securities from a limited menu of products without any comparison whatsoever"; and
  • NASAA is concerned with respect to the language used in the proposing release, which may limit an investor's recovery rights under the new standard.

Commentary / Steven Lofchie

A Cadwalader memorandum on the SEC's proposed Regulation Best Interest was titled " Choose One: Best Interest or Full Service." A major point (or argument) of the memorandum is that it is not possible to have both. To paraphrase, if a broker-dealer can not make any recommendation to a client without taking on a fiduciary obligation to that client, then the economics of being a full service broker-dealer (providing recommendations but just get paid for executing trades) just doesn't seem to work.

When NASAA declares that customers expect their service providers to act as fiduciaries and to consider all possible investment options before making a recommendation, isn't the logical conclusion that customers should hire investment advisers and that broker-dealers should act as execution-only firms? For many investors, this outcome would result in paying more, perhaps significantly more, for investment advice.

Maybe that is the right result, if one truly believes that the cost to investors of conflicted advice from broker-dealers was actually "$17 billon or more." (Obviously, one can argue whether that number is well-supported or completely made up). It follows from that figure, however, that retail investors, taken as a group, may purchase quite a lot of investment advice and still come out ahead in the long run.

To be clear, the argument that investors should receive advice only from persons who are willing to undertake a fiduciary obligation is defensible. But proponents of that argument should acknowledge that establishing it into law likely has some real-world costs, including perhaps the death of the full-service brokerage model. (This may be the way the world is moving, as the number of broker-dealers declines: down from 4,146 in 2013 to 3,726 in 2017.)

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