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SEC: It’s in Your Best Interest

June 12, 2019 - As reported by the WSJ, the SEC last week voted to approve a series of sweeping new rules, Regulation Best Interest (“RBI”), “designed to enhance the quality and transparency of retail investors’ relationships with investment advisers and broker-dealers”.  Why do we care?  While RBI primarily affects the relationship between retail investors and broker-dealers, aspects of the rule pertain to and impact institutional investment advisers (such as managers of loan mutual funds and EFTs).  Indeed, the LSTA in August submitted a comment letter (summarized here) on the proposed rule. 

So, what does RBI say?  On the retail side, RBI imposes a new standard of conduct for broker-dealers that requires them to act in the best interest of its clients. Previously, the standard for broker-dealers was an ill-defined “suitability”.  A broker-dealer must act in the retail customer’s “best interest” and cannot place its own interests ahead of the customer’s interests when making a recommendation of a securities transaction or an investment strategy involving securities.  In addition, RBI imposes disclosure obligations relating to the capacity in which it is acting, fees, and the scope of the service it is providing.  RBI also imposes a standard of care, diligence and skill when making a recommendation and requires the broker-dealer to consider the costs of the recommendation.   Finally, RBI imposes conflict of interest obligations, requiring that it establish, maintain and enforce written policies and procedures designed to identify, minimize or at least disclose potential conflicts. 

More relevant for loan fund managers (who are all “investment advisers’ rather than broker-dealers) are the changes to the form CRS and Investment Adviser interpretation under the RBI.   Investment advisers will be required to deliver a client relationship summary to retail investors at the beginning of their relationship.  The CRS must summarize information about services, fees and costs, conflicts of interest, legal standard of conduct, and whether or not the firm and its financial professionals have disciplinary history.  Interestingly, the SEC rejected the LSTA’s (and others’) suggestion that the SEC exempt investment advisers from the Form CRS requirement if their only advisory clients are “qualified clients” as defined under the ‘40s Act.  The LSTA argued that qualified clients are sophisticated, high net worth individuals who do not need the information in Form CRS which was crafted for “retail investors”. 

Finally, the SEC’s interpretation of an investment adviser’s duties conform to what has long been understood: an investment adviser owes a fiduciary duty to its clients under the Advisers Act.  This duty is principles-based and applies to the entire relationship between an investment adviser and its client.  The final interpretation reaffirms, and in some cases clarifies, certain aspects of the federal fiduciary duty that an investment adviser owes to its clients.  

What’s next?  The rules, forms, and interpretations will be published in the coming weeks in the Federal Register.  By June 30, 2020, registered broker-dealers must begin complying with RBI and broker-dealers and investment advisers registered with the Commission will be required to prepare, deliver to retail investors, and file a CRS for each client.  For more information about RBI contact LSTA General Counsel Elliot Ganz.  For a comprehensive analysis of the RBI, please see this memo from Dechert.

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