Harry N. Stout
109- Getting Financial Advice – The Rules Have Changed
Updated: Jan 15, 2021
In the FinancialVerse, I have encouraged you to get financial advice and to seek out qualified financial professionals to help you solve your financial problems. On June 30, a new federal government regulation went into effect that changes how you receive advice and the sales experience every time you purchase an investment product. Remember, investment products are generally stocks, bonds, mutual funds, structured investments or any investment where you can lose money.
Regulation Best Interest
The new regulation is called Regulation Best Interest (BI), which is a Securities and Exchange Commission (SEC) rule, that requires broker-dealers, registered investment advisers, and what are called dual registrants to only recommend financial products to their customers that are in their customers best interests, and to clearly identify any potential conflicts of interest and financial incentives they may have related to the sale of those products. This regulation is an improvement on the prior suitability requirements that were in place. If you want to read the rule in detail as well as background information on its creation go to sec.gov and finra.org. These websites present the history, content and interpretations of the new rule. I am going to simplify the rule for you and try to highlight its impact on consumers.
Before I begin, you should know that many industry groups, state regulators and trade organizations do not believe that the new rule and related regulations go far enough in improving consumer safeguards and the quality of advice given. There is much debate on this subject. What I can tell you is that in my view this new rule represents an improvement over prior requirements. Historically, broker-dealers' responsibilities have shifted over the past two decades from simply executing clients' trades for stocks and other securities to providing broader investment advice. Unlike financial advisors, who act as fiduciaries for their clients, broker-dealers have not been required to disclose potential conflicts of interest when recommending investing products or strategies.
Key Components of Regulation BI
Here are the summarized key components of Regulation BI as taken from the SEC’s website (sec.gov):
Disclosure obligation: Broker-dealers must disclose material facts about the relationship and investment 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 an investment recommendation to a 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 customer’s investment profile and make a recommendation is in the customer’s best interest. The regulation explicitly requires the broker-dealer to consider the costs of the recommendation.
Conflict of interest obligation: The broker-dealer must establish, maintain, and enforce written policies and procedures reasonably designed to identify and at a minimum disclose or eliminate conflicts of interest. This obligation specifically requires policies and procedures to:
- Mitigate conflicts that create an incentive for the firm’s financial professionals to place their interest or the interests of the firm ahead of the customer’s interest;
- Prevent material limitations on offerings, such as a limited product menu or offering only proprietary products, from causing the firm or its financial professional to place his or her interest or the interests of the firm ahead of the customer’s interest; and
- Eliminate sales contests, sales quotas, bonuses, and non-cash compensation that are based on the sale of specific securities or specific types of securities within a limited period of time.
Compliance obligation: Broker-dealers must establish, maintain and enforce policies and procedures reasonably designed to achieve compliance with Regulation Best Interest as a whole.
Written Relationship Summary
As part of the recommendation and sales process, you will receive a written relationship summary. Investment advisers and broker-dealers are required to deliver the Summary to investors at the beginning of their relationship. Firms will summarize information about services, fees and costs, conflicts of interest, legal standard of conduct, and whether or not the firm and its financial professionals have a disciplinary history. The Summary will have a standardized question-and-answer format to promote comparison by investors in a way that is distinct from existing disclosures. The Summary will also highlight the SEC’s investor education website, Investor.gov, which consumers can reference. The website offers the investing public educational information, including a series of educational videos designed to provide ordinary investors with some basic information about broker-dealers and investment advisers.
Ongoing State Based Initiatives
In addition to federal Regulation BI for investments, many states are adopting their own best interest and/or fiduciary requirements and are expanding the universe of products covered by these state-based laws from investments to include insurance products. You will need to consult with your qualified financial professional to see if your state has enacted such laws.
In a related development, the National Association of Insurance Commissioners (NAIC) has approved a revision to its annuity suitability regulation that sets the conflict of interest rules for insurance agents to follow when recommending annuity products to their clients.
With the NAIC’s final revision now approved, state insurance regulators can now adopt the model regulation into their own insurance regulations. By way of background, the NAIC is the United States’ standard-setting and regulatory support organization created and governed by the chief insurance regulators from the 50 states, the District of Columbia and five U.S. territories. Through the NAIC, state insurance regulators establish standards and best practices, conduct peer reviews and coordinate their regulatory oversight.
Similar to Regulation BI, the NAIC model regulation says that insurance producers shall act in the best interest of the consumer under the circumstances known at the time a recommendation is made, without placing the producer’s or the insurer’s financial interest ahead of the consumer’s interest. The model regulation now must become legislation in each state and approved as required by state law.
The way in which investment financial recommendations are delivered, conflicts of interest disclosed, and all the related disclosures and related documentation changed effective June 30. These changes have been made to improve the process and quality of advice you receive and attempt to make it more conflict free. Going forward, individual states may mandate additional requirements, disclosures or conduct by licensed individuals as well as expanding the universe of products to be covered to include selected insurance products.
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