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State regulators aiming to make Reg BI ‘mean something’

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AUSTIN, Texas — Broker-dealers strongly supported the SEC's new Regulation Best Interest — but that could come back to haunt them in the form of enforcement cases.

“If it's going to mean anything, if it's really going to be a step up from suitability, the way that that's going to happen is from regulatory examination and enforcement,” said Andrea Seidt, Ohio’s commissioner of securities and chairwoman of a North American Securities Administrators Association task force on the implementation of Reg BI.

While many state regulators were underwhelmed by the rule, Seidt told the hundreds of officials in attendance at a session at NASAA's annual meeting that they “have an opportunity to make Reg BI mean something.”

The final rule set to go into effect next June also includes a key change urged by NASAA members requiring cost to be taken into consideration when making recommendations. In video remarks to the conference, SEC Chairman Jay Clayton praised NASAA’s “thoughtful comments and constructive engagement” between the April 2018 proposal and the final rule earlier this summer.

BDs have blasted state fiduciary rules for creating differing standards among jurisdictions, but the industry backed Reg BI with notable enthusiasm for a complex new regulation.

State regulators should “start preparing to ask firms some really tough questions” around broker compensation practices, said SEC Investor Advocate Rick Fleming, who leads an independent office at the regulator. He also advised NASAA members to “get out there and make this standard meaningful” through enforcement.

“What I view as improvements in Reg BI could have been done with suitability, with more aggressive enforcement of suitability,” said Fleming. “One of the things I like about coming out with this new standard is it's sort of a clean slate. But whether it's any better than the old slate depends on how it's enforced, and you all have a part of that.”

Reg BI has been the focus of much of NASAA’s work in the past year, according to NASAA President Michael Pieciak of the Vermont Department of Financial Regulation. The organization launched the 11-state task force on implementation in July, he said in a speech to the annual meeting.

“Many of us have been asked to spend countless hours reviewing comment letters, meeting internally with our membership, meeting with the commissioners and their staff and the rule writing team,” Pieciak said. “Acknowledging that many of us are not satisfied with the final rule, I can assure you that NASAA's perspective pushed the final rule to a much better place for the investing public and is something that we should all be very proud of.”

Clayton cited the inclusion of the word “cost” in the final version of the rule as “just one of many examples” of how it “benefited greatly” from NASAA’s engagement with the SEC.

“The final Regulation Best Interest expressly requires that broker-dealers understand and consider the potential costs associated with a recommendation,” Clayton said. “Elevating 'cost' to the rule text — as suggested by NASAA — clarifies that this factor must always be considered when making a recommendation.”

Fleming reports to Clayton in his role, but his office also submits information on its objectives and activities to Congress each year without prior review. In a statement after the SEC issued the rule, he called it “a step in the right direction” but “not as strong as it could be.”

Explicitly mandating that brokers consider costs in their recommendations will help make enforcement easier, according to Fleming. He and Seidt expressed hope that it could also push down fees related to compensation.

“Brokers get paid more for selling some products than other products — that creates terrible incentives to sell those particular products,” Fleming said. “I hope that over time we'll see a leveling of compensation, which I think will deal with what I consider to be one of the biggest problems that leads to abuses in the BD space.”

NASAA’s task force will extend to the 2021 annual meeting to assess how Reg BI plays out in its first year, according to Seidt. She expects products like private placements, nontraded REITs, leveraged and inverse ETFs and variable annuities to be barometers, she says.

“It’s critically important,” Seidt said in an interview after the panel. “We definitely are going to be out there on the exam front trying to identify those products and practices.”

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