What Does the SEC’s ‘Reg BI’ Ruling Mean?

Unless you’re fluent in legal terms, official rulings can be difficult to understand. And learning how they could affect you can sometimes be even tougher. Last month, on June 5, the U.S. Securities and Exchange Commission approved its Regulation Best Interest ruling, or “Reg BI” for short. But to get to the bottom of how Reg BI could affect you as an individual investor, let’s dig in — starting at the top.

First of all, it’s important to know what the Securities and Exchange Commission, or SEC, is and what it does. Created to protect the interests of investors, the SEC also “promotes fairness in the securities markets, and shares information about companies and investment professionals to help investors make informed decisions and invest with confidence.” If the acronym sounds familiar, maybe you’ve used the SEC’s Investment Advisor Public Disclosure (IAPD) website. It offers a useful tool for vetting your financial professional or firm.

Now let’s explore the SEC’s new Regulation Best Interest.

Reg BI and Form CRS

The new Reg BI ruling states that broker-dealers “will be required to act in the best interest of a retail customer when making a recommendation of any securities transaction or investment strategy involving securities to a retail customer.” To break that down a bit, a “retail customer” is an individual investor as opposed to, for example, a big bank or insurance company. So, if you’re investing your savings for life goals like a home down payment or retirement, that’s you! 

The gist of the new ruling is that broker-dealers can’t put their own interests ahead of your interest when making recommendations to you. This offers better protection for investors just like you as broker-dealers’ clients must now come first. It’s a change from a standard broker-dealers were previously held to, called the “suitability standard.” Under the suitability standard, broker-dealers were required to provide “suitable” recommendations, or those that would be, more or less, ok for clients and their goals. Reg BI takes that standard a bit further now that their recommendations must be in the best interests of, or truly good for, investors. 

Another important aspect of Reg BI is that broker-dealers must also disclose any potential conflicts of interest. They’ve also got to provide information on any incentives available to them. This is to help you as an investor better understand why these licensed financial professionals are recommending certain products. It can also help you make the most informed decisions regarding your investments.

Although the SEC issued it on June 5, 2019, Reg BI’s effective date is Sept. 10, 2019. But that doesn’t necessarily mean you’ll see any changes this year. In fact, although some broker-dealers may start implementing it sooner, the compliance deadline is June 30, 2020 — over a year after the initial ruling issuance.

So, what other changes can you expect? Along with Reg BI, the SEC also created another rule. While Reg BI only applies to broker-dealers, both registered investment advisers (RIAs) and broker-dealers will be now required to provide a new form to retail clients. It’s called the Form CRS Relationship Summary, and it’s an easy-to-understand summary of the advisory relationship, as its name implies. It’ll include descriptions of “services, fees and costs, conflicts of interest, legal standard of conduct, and whether or not the firm and its financial professionals have disciplinary history” — no translation from legalese into English required.

RIAs and Broker-Dealers — What’s the Difference?

But what’s the difference between a broker-dealer and an RIA when both are independent financial professionals? Broker-dealers buy and sell securities — aka stocks, bonds, or other investments — on behalf of a firm or customers and receive commissions for selling products. RIAs, on the other hand, are fiduciaries — required to act in their clients’ best interests at all times — who receive compensation for the advice they provide.

Did you catch the words “best interests” in the description of RIAs? That’s where things start to get confusing. After all, Reg BI applies to broker-dealers and requires they also act in clients’ best interests. And why, you ask, doesn’t Reg BI apply to RIAs even though the SEC will require both broker-dealers and RIAs to provide this new Form CRS? 

It all goes back to another word I mentioned when describing RIAs — fiduciary — and the differentiating factor is when the “best interest” aspect applies. While the SEC will soon require broker-dealers to act in clients’ best interests when making recommendations, fiduciary RIAs are always required to act in their clients’ best interests. So Reg BI doesn’t change much for RIAs because they must already put their clients first at all times.

The line is blurry because Reg BI attempts to create an equivalence to a fiduciary standard for broker-dealers without explicitly calling it that since it’s limited to when a broker-dealer is making a recommendation. It’s is a good step in the right direction for consumers, in my humble opinion, but still not enough to truly separate the pharmacist from the doctor — or the best interest broker-dealer from the fiduciary RIA, in this case.

What do you need to know when working with a financial professional?

I might sound like a broken record, but the important bit to understand about the SEC’s new rulings is that RIAs are already fiduciaries acting in their clients’ best interests at all times while Reg BI will require broker-dealers to act in their clients’ best interests, too, but only when making recommendations. And both RIAs and broker-dealers will have to start spelling out what their advisory relationships with clients will be like through Form CRS.

If you’re considering working with a financial professional or are already, here are a few basic guidelines to help you better grasp the new SEC rulings:

• Understand that a broker-dealer can’t put his or her own interest before yours when making recommendations once Reg BI is in force. It’s more protection for you as an investor.
• You may want to consider the difference between Reg BI applying to individual recommendations from broker-dealers versus the fiduciary duty that applies to the entire advisory relationship with RIAs.
• Be mindful of the differences between how RIAs and broker-dealers earn their fees. It can also be helpful to familiarize yourself with the industry designations they can hold.
• Use the new Form CRS for a clear idea of a broker-dealer or RIA’s proposed advisory relationship, fees charged, and any conflicts of interest.
• Keep in mind that many financial professionals — including broker-dealers — have long gone above and beyond for their clients, acting as fiduciaries even before the SEC issued Reg BI.

Speaking of industry designations as well as going above and beyond, Certified Financial Planner^™ professionals have long been required to take a fiduciary oath in addition to educational, experiential, and ethical requirements. Seeking out a CFP^® pro can be a strong option for investors looking for a financial professional to work with. And, even with Reg BI compliance soon becoming mandatory, it’s still a good idea to ask financial pros additional questions to ensure the right fit for you and your financial future.