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SEC Adopts "Retail Best Interest" Rulemaking Package's picture
Commentary by Steven Lofchie

The SEC adopted a rulemaking package designed to enhance retail investors' protections when dealing with broker-dealers and investment advisers. The rulemaking package consists of (i) Regulation Best Interest, (ii) the Form CRS Relationship Summary, (iii) an interpretation of investment advisers' fiduciary duty, and (iv) an interpretation of the "solely incidental" prong of the broker-dealer exclusion under the Advisers Act. The rules and forms will become effective 60 days following publication in the Federal Register, with a transition period lasting until June 30, 2020. The interpretations will become effective upon publication in the Federal Register.

Rulemaking Package

Regulation Best Interest ("Reg. BI") will require broker-dealers not to prioritize their interests ahead of customers' when making recommendations regarding a securities transaction, investment strategy or account recommendation. The regulation provides that a broker-dealer will satisfy the best interest standard if it complies with the following obligations:

  • Disclosure: disclose material information about the relationship and recommendations, including material conflicts of interest;

  • Care: act with reasonable "diligence, care and skill" when making a recommendation by (i) understanding potential risks, rewards and costs, (ii) evaluating the recommendation against the customer's interests, (iii) advising based on the customer's best interests, and (iv) explicitly considering any associated costs;

  • Conflict of Interest: establish policies and procedures reasonably designed to identify and address conflicts of interest that will (i) monitor conflicts that incentivize professionals to prioritize their interests over customers', (ii) prevent material limitations on offerings from incentivizing professionals to prioritize their interests over customers', and (iii) remove any incentives for professionals (i.e., sales contests, sales quotas, bonuses, and non-cash compensation) that rely on the sale of specific securities or types of securities within a time-limited period; and

  • Compliance: implement policies and procedures that comply with Reg. BI as a whole.

Reg. BI also imposes recordkeeping requirements relating to retail customer information.

At the beginning of their relationship with retail investors, investment advisers and broker-dealers will be required to deliver the Form CRS Relationship Summary. According to the SEC, the summary will provide key information about the firm and include a standardized question-and-answer format to help investors compare the different types of firms.

In the investment adviser interpretation, the SEC reaffirms and clarifies certain aspects of the fiduciary duty that investment advisers owe to their clients. These fiduciary duty requirements include (i) the "duty of care," which includes the obligation to provide advice in a client's best interest, the duty to seek best execution, and the duty to provide advice and monitoring over the course of the relationship, and (ii) the "duty of loyalty," which requires that an adviser not place its own interests ahead of its client's interests.

Additionally, the SEC clarified the exemption under the Advisers Act that excludes certain broker-dealers from the definition of investment adviser (a.k.a. the "solely incidental" interpretation). Specifically, a broker-dealer is excluded from the definition, even if it is providing advice on the value and characteristics of securities or securities transactions, so long as the advice is provided in connection with, and is reasonably related to, its primary business and it receives no special compensation.

Commission Response

SEC Chair Jay Clayton expressed his support for the rulemaking package and characterized criticism against the package as "misguided." Mr. Clayton responded to specific criticisms, saying that (i) Reg. BI cannot be implemented through disclosures alone, (ii) the Form CRS Relationship Summary is a huge improvement over existing disclosures for investors, and (iii) the fiduciary interpretation does not weaken the existing fiduciary duty for investment advisers.

SEC Commissioner Robert J. Jackson Jr. dissented, saying that the rulemaking package does not raise the standard for investment advice. Specifically, Mr. Jackson stated that the package "retain[s] a muddled standard that exposes millions of Americans to the costs of conflicted advice." Additionally, he criticized the rulemaking's inference that investment advisers are not true fiduciaries.

SEC Investor Advocate Rick Fleming stated that, while Reg. BI is a step in the right direction, the rulemaking package contains notable issues. According to Mr. Fleming, (i) the fiduciary interpretation undermines investor protections, (ii) the Form CRS relationship summary is likely to confuse investors, and (iii) the "solely incidental" interpretation does not better clarify the distinction between broker-dealers and investment advisers but, rather merely formalizes the SEC's longstanding deference to certain broker-dealer activities.

SEC Commissioner Elad L. Roisman approved of the rulemaking package and advised the SEC to work with the industry and the public to complete a smooth transition.

See also this Client & Friends Memorandum and our Reg. BI topic page.


Cadwalader's initial memorandum on the Reg. BI proposal was entitled: “Choose One: Best Interest or Full Service.” The conclusion of that analysis was that the adoption by the SEC of a “best interest” standard for broker-dealers was arguably inconsistent with broker-dealers providing incidental investment advice to customers as part of full-service brokerage. The reasoning is straightforward: the compensation that broker-dealers are paid for transaction execution by retail investors trading infrequently and in small dollar amounts cannot really support the individualized attention that the SEC demands with the best interest standard.

The SEC acknowledged this risk in its release adopting Reg. BI. In light of the concern that an overly burdensome Reg. BI would effectively kill full-service brokerage, the SEC tried to "split the baby" by “balanc[ing] the concerns of the various commenters of enhancing retail investor protection . . . while preserving, to the extent possible, retail investor access (in terms of choice and cost) to differing types of investment services and products."

In attempting this admittedly difficult, and probably impossible, balancing act, the SEC likely tilted fairly strongly in favor of retail investor protection and against retail investor access, although Commissioner Jackson believes that the SEC should have gone even further.  Firms continuing to provide a full-service brokerage option to retail customers will need to review their procedures for dealing with retail customers very thoroughly.

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Definition of Investment Adviser, Form CRS, IA Standard of Conduct, Regulation Best Interest, Sales Contests and Non-Cash Compensation, Solely Incidental Activities
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