Regulation Best Interest and Form CRS

Contents

1. What the rule requires
2. Where it came from
3. The relationship summary
4. The adoption timeline
5. What critics and surveys found
6. What changed and what did not

Brent O’Mara holds the Certified Fund Specialist and Accredited Investment Fiduciary designations, and the rule described here is the SEC’s attempt to bring brokers nearer to the duty that second credential is named for. Regulation Best Interest is an SEC rule under which a broker dealer making a recommendation to a retail customer must act in that customer’s best interest at the time the recommendation is made, without placing its own financial or other interest ahead of the customer’s.¹ Form CRS is the short relationship summary that advisers and brokers alike must hand to a retail investor when a relationship begins.³ The two came out of the same vote.

What the rule requires

The SEC’s announcement of the proposal set out the duty and the way a broker would discharge it. The duty is to act in the retail customer’s best interest when recommending any securities transaction or investment strategy, and the agency explained that the rule was designed to make clear that a broker dealer may not put its financial interests ahead of the customer’s.¹ Three specific obligations do the work: a disclosure obligation, a care obligation and a conflict of interest obligation, each described in the announcement as a condition the broker must satisfy.¹ The announcement framed the whole package around three principles applied to advisers and brokers alike, clear disclosure, due care and attention to conflicts of interest, while saying that the specific obligations of each would be tailored to the kind of relationship offered.¹ It also proposed that advisers and brokers state their registration status plainly in communications with investors, and that certain brokers be restricted from using adviser or advisor in a name or title, because the words were so close to investment adviser that customers might take a brokerage for a registered advisory firm.¹

Figure

The three obligations in the proposal

1. 01
   DisclosureDisclose to the retail customer the key facts about the relationship, including material conflicts of interest.
2. 02
   CareExercise reasonable diligence, care, skill and prudence to understand the product and have a reasonable basis to believe a recommendation, and a series of transactions, is in the customer's best interest.
3. 03
   Conflict of interestKeep policies and procedures designed to identify conflicts arising from financial incentives and at a minimum disclose and mitigate, or eliminate, them.

Where it came from

The rule’s own record gives the dates. The SEC voted on April 18, 2018 to propose a package of rules and interpretations meant to improve the quality and transparency of investors’ relationships with advisers and brokers while preserving access to different kinds of advice and products.¹ The package had four parts: the best interest rule for brokers, an interpretation reaffirming the fiduciary duty that advisers owe under the Advisers Act, the relationship summary, and a restriction on certain brokers using the words adviser or advisor in a name or title.¹ The agency said it had been considering these questions since the mid 1990s, had studied them under a mandate in the 2010 financial reform law, and had sought public input in June 2017.¹ The older debate is described under suitability versus fiduciary duty, and the adviser side under the Investment Advisers Act.

The relationship summary

Form CRS is the plainest part of the package. The SEC’s investor education site describes it as a client or customer relationship summary that advisers and brokers must deliver when starting a relationship or when an account changes, for example when an IRA is rolled over, and notes that advisers and brokers offer different services and are paid differently, so reading the summary can help a person decide whether a firm fits.³ The same site suggests using the conversation starters printed in the summary when interviewing a professional, and pressing for information about an investment’s risks before buying.⁴ As proposed, the summary was a standardized short form document of at most four pages covering the principal types of services, the legal standards of conduct that apply to each, the fees a customer might pay, and certain conflicts of interest, and it was meant to supplement the more detailed disclosures advisers already make in Form ADV.¹

The adoption timeline

The final rule was adopted on June 5, 2019 as release 34 86031, published in the Federal Register on August 9, 2019, and took effect on September 10, 2019; the same day the agency issued an interpretation of the solely incidental part of the broker dealer exclusion from the definition of investment adviser.² On the day of adoption the president of the state securities administrators’ association said that state authorities had long held state registered advisers to a rigorous fiduciary standard, had called on the SEC to strengthen the proposal, and would study the lengthy final releases against the comment letters they had filed.⁵

Figure

From proposal to effect

1. 01
   April 18, 2018The SEC votes to propose the rule, release 34 83062, together with the adviser interpretation and Form CRS.
2. 02
   May 9, 2018The proposal is published in the Federal Register.
3. 03
   June 5, 2019The final rule is adopted as release 34 86031, with an interpretation of the solely incidental exclusion issued the same day.
4. 04
   September 10, 2019The rule takes effect.

What critics and surveys found

Reaction split along familiar lines. In April 2018 the SEC’s chairman told a House subcommittee that the proposed standard carried fiduciary principles within it, while critics called the proposal too close to the suitability rule brokers already followed, and one member of the panel asked what brokers would call themselves once the word adviser was restricted.⁸ That September a coalition of consumer groups released testing of the proposed relationship summary: sixteen interviews in three cities found that the drafts did little to help people understand the distinction between advisers and brokers, and that most participants misread the phrase best interest as a promise of higher earnings.⁶ A 2020 survey of 1,577 adults with retirement or investment accounts found that most were unaware of the rule, and the survey’s authors read the rule as stating that best interest does not mean the fiduciary standard of care that applies to advisers.⁷

What changed and what did not

What changed is clear from the record. Since September 2019 a broker recommending a securities transaction to a retail customer has owed a best interest obligation built from disclosure, care and conflict management, and every retail investor opening a relationship with an adviser or a broker receives a short summary of services, standards and fees.² What did not change is the existence of two standards. Advisers still owe the fiduciary duty the SEC reaffirmed in the same package, brokers answer to the best interest rule, and the relationship summary exists partly because the difference remains hard for the public to see.¹ Which arrangement suits a given household rests on individual circumstances, tax and estate matters included, so the summary is a starting point for a conversation with qualified professionals rather than a conclusion.