What Broker/Dealers Need to Know About the SEC's Regulation Best Interest
Written by Jasmin Sethi for SCA client, Morningstar.
The SEC has adopted Regulation Best Interest, raising the standard for brokers above the current suitability standard to act in the best interest of their clients. The rule passed with a 3-to-1 vote on June 5, 2019, as part of a larger ruling.
Below, we explore key elements of this rule and its possible impact on broker/dealers.
What Regulation Best Interest means for conflicts of interest
The rule stipulates that broker/dealers will either have to eliminate, or disclose and mitigate, material conflicts of interest. This requirement will have significant impacts on broker compensation and advice models, though it does not force broker/dealers to upend their business model to the extent that the Department of Labor’s regulation would have.
A couple of ways this rule takes shape include:
It explicitly prohibits contests, quotas, bonuses, and noncash compensation that reward sales of a particular security or type of security in a limited period of time.
Firms will likely need to eliminate incentives that encourage individual broker representatives to sell certain products.
The preamble discusses product reviews and tests of representative knowledge about products as potential means of mitigating conflicts. Also, in some cases, products should simply not be recommended if a conflict cannot be resolved. Thus, it is difficult to know what forms of mitigation combined with disclosure for material conflicts of interest—short of elimination—will be considered sufficient under the rule. Future enforcement may clarify this.
Firms will need to evaluate their business models, asking questions such as:
