By Anne Sherry, J.D.
NASAA’s comments on the SEC’s suite of investor-protection rule proposals include a suggestion that the SEC rename Regulation Best Interest to avoid confusion and that it withdraw the example Forms CRS that it included in the relationship summary proposal. The organization of state regulators supports the overall approach of raising the standard for broker-dealers without weakening current standards for investment advisers, but said that the proposals require significant improvements to further the best interests of investors.
The comment letter also calls for an outright ban on sales contests at broker-dealers, a position that SEC Chairman Jay Clayton shares, according to a recent statement. NASAA said that it cannot envision a situation where a sales contest would be consistent with a broker-dealer’s duties under Reg BI, but the continued existence of abusive practices will undermine investor confidence. The organization added that the SEC should also ban preferential treatment of customers in the allocation of investment opportunities such as IPOs.
Use and definition of “best interest.” In NASAA’s view, Reg BI and the obligation it imposes should be relabeled the “Broker-Dealer Standard of Conduct” rather than “Regulation Best Interest” to avoid conflating a broker-dealer’s best-interest duties with an investment adviser’s fiduciary duties. Should the SEC retain the term “best interest,” it should define it consistently with the definition offered by Commissioner Stein in her statement on the proposals. Adopting that definition but making it clear that the standard applies to all customers (i.e., striking the “retail” qualifier throughout the proposal) would expand the scope of Reg BI, make clear that the duty is objective, expressly invoke the principles against which the financial professional’s conduct will be evaluated, and expressly delineate the time at which the conduct will be evaluated.
Comparison to alternative products. NASAA takes the SEC’s position to be that a broker-dealer could satisfy its best interest duties by recommending securities from a limited menu of products, without any comparison outside of this selection. The group “strongly disagrees” with this position and urges the SEC to make clear that firms do need to look outside their own offerings in considering factors such as cost, complexity, liquidity, and risk. NASAA is not calling for a “maximalist application” that would require broker-dealers and their associated persons to become knowledgeable about every investment, but they should be held accountable for knowing broadly about competing asset classes and investment strategies.
Compliance and overlap with Advisers Act. The SEC requested comment on whether contractually required monitoring duties should be subject to a best interest standard or be deemed to be investment advisory in nature. NASAA responded that the provision of ongoing monitoring services should trigger application of the Investment Advisers Act. The group also sees the current proposal as “an excellent opportunity” for the SEC finally to treat broker-dealers that exercise discretionary trading authority as investment advisers, as it proposed in 2007.
The Commission should also offer guidance so that associated persons can determine whether the information they are providing is a recommendation subject to best interest duties or advice subject to fiduciary duties. An even better alternative, NASAA wrote, would be to require firms to treat clients that maintain both advisory and brokerage accounts as advisory clients.
NASAA also said that the SEC should reconsider permitting broker-dealers to use a risk-based compliance system to comply with its best interest duties in lieu of transaction-by-transaction assessments of recommendations. Implementing an appropriate compliance system is a necessary but not always sufficient step toward compliance, the group wrote.
Private enforcement. In its proposal, the SEC stated that it does not believe Reg BI would create, and it does not intend to create, a new private right of action or right of rescission. NASAA asked the SEC to confirm that the rule’s obligations would be enforceable through FINRA arbitration or private litigation. The agency should also emphasize that scienter is not required to establish a violation of Reg BI and that it has no intention of preempting state law.
Form CRS. NASAA said that while it “appreciate[s] the SEC’s efforts to develop Form CRS,” it would be better to review and revise Forms ADV and BD rather than adding a new form to the disclosure structure. If it goes forward with Form CRS, the Commission should withdraw the example disclosures it included in the proposal so that these examples do not “cabin the stylistic freedom of broker-dealers and investment advisers to craft their own Form CRS disclosures in ways that best speak to their customers.” The SEC should delay implementation of Form CRS until the form can be thoroughly analyzed and tested through focus groups. NASAA’s comment letter includes specific ways in which the form should be revised should the SEC move forward with it.
Standards of conduct for investment advisers. NASAA called the investment adviser release a “useful resource,” but asked the SEC to defer to state securities regulators regarding registration of investment adviser representatives and any potential continuing education requirements. By expanding the discussion around the adviser’s duty to mitigate conflicts, the SEC could add legal clarity that the duty to mitigate conflicts is an affirmative obligation that must be performed in an objectively reasonable manner.
Borg statement. NASAA President Joseph P. Borg said he appreciated Clayton’s leadership on these issues. “Given our members’ shared responsibility with the SEC for oversight of the firms and individuals that will be impacted by the proposals, NASAA is anxious to work closely with the Commission on further refinements to the proposals and we hope our constructive comments are well received and considered fully.”