Morningstar Magazine - August/September 2018 - 15

when it votes on the final rules package. Still, the
most likely outcome is that the general principles
in the proposal will underpin the final rule.
What's the Bottom Line?

This is potentially a major change to how the SEC
thinks about regulating the conduct of financial
advisors. The rule aims to hold financial professionals to higher standards of conduct, even
if they are registered as broker/dealers rather than
as Registered Investment Advisors. Further,
new interpretive guidance aims to clarify the high
standard of care the SEC expects from RIAs.
The reason for the proposed changes is that
regulators have worried for some time that broker/
dealers have incentives that may lead them
to give conflicted advice and that ordinary
investors do not know the differences between
types of financial professionals.
Despite being one of the key tools the government uses to help investors, the regulation
of advice has been uneven and confusing.
Divergent regulations for broker/dealers and RIAs
have been overshadowed by converging
business models. Further, the standards
of care are different depending on whether an
advisor is acting as a fiduciary under the
Employee Retirement Income Security Act or not.
Representatives from broker/dealers and RIAs
(operating under and outside of ERISA)
all represent themselves as advisors but operate
under very different standards of conduct
depending on how they are registered and in
what context they give advice.
That mismatch is a big part of the reason many
in industry and advocacy groups called on the SEC
to propose a uniform standard of advice. But
the SEC did not do so. Rather, it proposed raising
the standard of care for broker/dealers, while
maintaining a different, higher standard for RIAs.
The key things you need to know:
3 For the first time ever, the SEC would require
broker/dealers to act in the "best interests" of their
clients when they provide advice by imposing a
new rule with the on-the-nose name of Regulation
Best Interest. The crux of this new regulation is

that it requires broker/dealers to have policies and
procedures to mitigate conflicts, particularly
those caused by financial incentives to recommend
one product over another. This kind of conflict of
interest was a main rationale for the DOL's
fiduciary rule, as well.
3 There are a lot of questions about what this bestinterest standard means. For example, it is
not clear yet to what extent the standard differs
from the Financial Industry Regulatory
Authority's suitability standard. Clearly, the SEC
proposal is a stricter standard, but exactly
how much stricter seems open to interpretation
and may depend on the appetite a future
commission has for aggressive enforcement. The
SEC declined to put clear bright lines around
prohibited kinds of compensation.
3 Despite the new Regulation Best Interest
rule, broker/dealers would not operate under the
same fiduciary standards that apply to RIAs under
the proposal. In other words, the SEC is not
seeking to fully align standards across broker/
dealers and RIAs.
3 The preamble to the rule references rollovers from
IRAs-a key concern the DOL had when issuing
its fiduciary rule. Further, the interpretive
guidance similarly emphasizes the obligations RIAs
have when recommending rollovers. However,
unlike the fiduciary rule, the SEC regulation
does not specifically require different procedures
and documentation for evaluating whether
a rollover is in a client's best interest, an area that
needs further clarification.
3 Despite maintaining two standards of care for
broker/dealers and RIAs, the rule aims to reduce
confusion by requiring financial professionals
to provide investors with a new form called
CRS. This would provide a "relationship summary"
to clients and prospective clients designed
to help them understand the services they can
expect, conflicts of interest that might influence
the advice they receive, and fees they will
pay, among other disclosures. Additionally, broker/
dealers would no longer be able to use the term
"advisor" (or "adviser," with an "e"). However,
dual-registrants would be able to continue to call
themselves advisors.

How Is the SEC Proposal Different?

The SEC's rule diverges from the DOL's fiduciary
rule in many ways, but three stand out:
1 The SEC rule does not rely on lawsuits as an

enforcement mechanism, which allows much more
certainty in firms' compliance plans.
2 The SEC rule would apply to both retirement

and nonretirement accounts, although it
would not regulate some kinds of advice that are
subject to state regulation, particularly very
small investment advisors and certain insurance
products, such as single-premium annuities.
3 The SEC rule is more focused on mitigating

conflicts of interest than avoiding them altogether.
The DOL's warranty requirements explicitly
prohibited sales quotas, differential compensation
for selling similar products, and sales contests,
among other potential practices that could lead
to conflicted advice. In contrast, the SEC
rule relies on requiring written procedures to
mitigate conflicted advice stemming from broker/
dealers' misaligned financial incentives.
The differences are due to the different laws
empowering the SEC and the DOL, and to historical
differences in the agencies' approach to regulation.
What's Next?

The rules package was published in the Federal
Register, and the period for public comment closes
Aug. 7. The SEC will consider these comments
before publishing a final rule. Meanwhile, uncertainty surrounds the DOL's fiduciary rule.
The department may not appeal the 5th Circuit's
ruling, but it also may write a narrower rule to
complement the SEC's approach.
In the end, however, we expect both rules to
accelerate an existing trend: Advisors are
moving away from a sales model toward a relationship model where they provide best-interest
advice to clients. From our preliminary analysis
of public filings, we think firms are doing
an increasingly good job of managing conflicts
of interest. K
Aron Szapiro is director of policy research with Morningstar.

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Table of Contents for the Digital Edition of Morningstar Magazine - August/September 2018